nep-cta New Economics Papers
on Contract Theory and Applications
Issue of 2020‒01‒27
seven papers chosen by
Guillem Roig
University of Melbourne

  1. Multi-product bargaining, bundling, and buyer power By Dertwinkel-Kalt, Markus; Wey, Christian
  2. Financing PPP Projects with PVR Contracts: Theory and Evidence from the UK and Chile By Eduardo Engel; Ronald Fischer; Alexander Galetovic; Jennifer Soto
  3. Managerial Overconfidence and Self-Reported Success By Nikolaj Kirkeby Niebuhr
  4. Specific Human Capital and Real Wage Cyclicality: An Application to Postgraduate Wage Premium By Gu, Ran
  5. The effect of horizontal pay dispersion on the effectiveness of performance-based incentives By Grabner, Isabella; Martin, Melissa A.
  6. The Dark Side of Monetary Bonuses : Theory and Experimental Evidence By Gonzalez-Jimenez, Victor; Dalton, Patricio; Noussair, Charles
  7. Vertical Integration as a Source of Hold-up: an Experiment By Allain, Marie-Laure; Chambolle, Claire; Rey, Patrick; Teyssier, Sabrina

  1. By: Dertwinkel-Kalt, Markus; Wey, Christian
    Abstract: We re-consider the bilateral bargaining problem of a multi-product, manufacturer-retailer trading relationship. O'Brien and Shaffer (Rand JE 35:573-598, 2005) have shown that the unbundling of contracts leads to downward distorted production levels if seller power is strong, while otherwise the joint profit maximizing quantities are contracted (which is also always the case when bundling contracts are feasible). We show that the unbundling of contracts also leads to downward distorted output levels when the buyer firm has sufficient (Nash) bargaining power (i.e., buyer power). Our result is driven by cost substitutability (diseconomies of scope).
    Keywords: Vertical Restraints,Bundling,Buyer Power
    JEL: L13 L41 K21
    Date: 2019
  2. By: Eduardo Engel; Ronald Fischer; Alexander Galetovic; Jennifer Soto
    Abstract: Risk allocation is an essential component of a successful public-private partnership contract financed with user fees. For many of these projects, demand risk is large and mostly exogenous. This suggests that we evaluate contract designs that do not force the concessionaire to bear risk it cannot manage. In this paper we study present-value-of-revenue (PVR) contracts, which have this property. Under a PVR contract, the regulator sets the discount rate and the tariff schedule and firms compete on the present value of tariff revenue. The lowest bid wins and the contract lasts until the winning firm collects revenue equal to its bid. We provide a theoretical analysis comparing debt financing under a fixed term concession and PVR. We show that, other things equal, debt is less risky under PVR, particularly against large systemic shocks, and therefore debt-to-capital ratios can be higher. In addition, we show that the view that PVR does not mesh easily with fixed maturity debt is wrong. The reason is that demand realizations are independent of contractual forms. Finally, we analyze the experience with PVR contracts, considering two early examples from the UK and close to thirty PVR contracts for highways and airports in Chile. We conclude that PVR contracts have been at least as attractive to lenders than their fixed term counterparts. We also provide evidence of better incentives under PVR, in particular, a significant reduction of contract renegotiations. JEL Codes: H44, R42. Key words: default risk,fixed term contract,flexible term contract,Infrastructure concession,prepayment risk,project finance.
    Date: 2019
  3. By: Nikolaj Kirkeby Niebuhr (Department of Economics and Business Economics, Aarhus University)
    Abstract: I consider the optimal contract for an overconfident manager in a principal-agent model with moral hazard where the contract is written on the earnings of the firm. Overconfidence causes the manager to overestimate his ability to affect the outcome of the firm. Overconfidence first reduces cost of agency, and if the level of overconfidence is significant enough, it causes the manager to wager on his wrong beliefs. The accounting system obscures the outcome of the manager's effort, which attenuates the effect of significant overconfidence and decreases the principal's profit. Inducing the manager to truthfully communicate his self-observed success allows the principal to directly contract on the cause of disagreement, the manager's effect on firm outcome. This reduces the risk premium for a slightly overconfident manager and emphasizes the wager effect for a significantly overconfident manager. The value of communication is first decreasing in overconfidence for a slightly overconfident manager and then increasing in overconfidence for a significantly overconfident manager.
    Keywords: Overconfidence, Moral hazard, Communication, Disclosure
    JEL: D83 D86 D91 M41
    Date: 2020–01–10
  4. By: Gu, Ran
    Abstract: This paper examines how specific human capital affects labour turnover and real wage cyclicality in a frictional labour market. I develop an equilibrium search model with long-term contracts and imperfect monitoring of worker effort. Imperfect monitoring creates a moral hazard problem that requires firms to pay efficiency wages. The optimal contract implies that more specific capital reduces job separation, thereby alleviating the moral hazard and increasing wage stability over the business cycle. I apply this model to explain novel stylised facts about the cyclicality of the postgraduate-undergraduate wage premium. Postgraduate degree holders experience lower cyclical variation in real wages than those with undergraduate degrees. This effect is significant for workers with a long tenure, but not for new hires. Moreover, postgraduates have more specific human capital than undergraduates. Estimates reveal that specific capital can explain the educational gaps both in labour turnover and in real wage cyclicality.
    Keywords: specific human capital, real wage cyclicality, postgraduates, wage premium, contracts, search
    JEL: E24 E32 I24 J31 J64
    Date: 2019–12–02
  5. By: Grabner, Isabella; Martin, Melissa A.
    Abstract: In response to general calls for increased transparency in society, pay transparency policies are growing in importance. Given that pay transparency unavoidably gives employees the opportunity to make comparisons between themselves and others, in this study we address the question of how these comparisons impact the incentive effects of performance contingent pay, and consequently their performance outcomes. Specifically, we empirically examine whether horizontal pay dispersion alters the effectiveness of performance-based pay contracts, which firms typically use to incentivize effort. Exploiting our unique access to a large healthcare provider, we document the moderating role of horizontal pay dispersion on the effectiveness of individual monetary incentives at generating increased individual performance. To provide a more nuanced understanding of the moderating effect of pay dispersion, we further examine the boundary conditions of the proposed interaction. In particular, we examine the differential effect of overall pay dispersion on employees that rank high versus low in the pay distribution and disaggregate overall pay dispersion into performance-related versus performance-unrelated pay dispersion. Our findings consistently show a positive moderating effect of pay dispersion when employees are more likely to consider the observed pay dispersion as legitimate, and a negative moderation effect when this is less likely the case. Our study strengthens the understanding of how individual level incentives function in the context of a multi-person firm setting. Our results document that individual incentives are effective, but also suggest that pay dispersion can have a significant influence on the incentive-performance relation. These findings provide some evidence that individuals are concerned not only with their own payout, but also with that of others, and that this concern has a significant impact on individual’s effort provision, and consequently performance.
    Keywords: Incentive compensation, pay-for-performance sensitivity, social comparisons, pay dispersion, pay transparency
    Date: 2020–01–09
  6. By: Gonzalez-Jimenez, Victor; Dalton, Patricio (Tilburg University, Center For Economic Research); Noussair, Charles
    Abstract: To incentivize workers and boost performance, firms often offer monetary bonuses for the achievement of production goals. Such bonuses appeal to two types of motivations of the worker. On the one hand, the existence of a goal, on its own, triggers an intrinsic motivation associated with the desire to not fall short of the goal. On the other hand, the money paid to achieve the goal constitutes an extrinsic motivation. This paper studies the possibility that these two effects are substitutes when workers set their own goals. We develop a theoretical model that predicts that if the worker is sufficiently loss averse and faces uncertainty about reaching a production goal, offering a monetary payment contingent on reaching such a goal is counterproductive. This is because under the presence of monetary bonuses, the loss averse worker prefers setting lower goals, which yield lower but more likely bonus payments. Lower goals, in turn, negatively affect subsequent performance. Results from a laboratory experiment corroborate this prediction. This paper highlights the limits of monetary bonuses as an effective incentive when workers are loss averse.
    Keywords: goal-setting; contracts; loss aversion; bonuses; experiment
    JEL: J41 D90 C91 D81
    Date: 2020
  7. By: Allain, Marie-Laure; Chambolle, Claire; Rey, Patrick; Teyssier, Sabrina
    Abstract: In a vertical chain in which two rivals invest before contracting with one of two competing suppliers, partial vertical integration may create hold-up problems for the rival. We develop an experiment to test this theoretical prediction in two setups, in which suppliers can either pre-commit ex ante to appropriating part of the joint profit, or degrade ex post the support they provide to their customer. Our experimental results confirm that vertical integration creates hold-up problems in both setups. However, we observe more departures from theory in the second one. Bounded rationality and social preferences provide a rationale for these departures.
    Keywords: Vertical Integration; Hold-up; Experimental Economics; Bounded Rationality; Social Preferences.
    JEL: C91 D90 L13 L41
    Date: 2020–01

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