nep-cta New Economics Papers
on Contract Theory and Applications
Issue of 2020‒12‒21
five papers chosen by
Guillem Roig
University of Melbourne

  1. Asymmetric Information and Delegated Selling By Maarten Janssen; Santanu Roy
  2. Collective Moral Hazard and the Interbank Market By ; Joseph E. Stiglitz
  3. The Robustness of Incomplete Penal Codes in Repeated Interactions. By Olivier GOSSNER
  4. Consumer Vulnerability and Behavioral Biases By Hanming Fang; Zenan Wu
  5. Promise, Trust and Betrayal: Costs of Breaching an Implicit Contract By Levy, Daniel; Young, Andrew

  1. By: Maarten Janssen (University of Vienna); Santanu Roy (Southern Methodist University)
    Abstract: Asymmetric information about product quality can create incentives for a privately informed manufacturer to sell to uninformed consumers through a retailer and to maintain secrecy of upstream pricing. Delegating retail price setting to an intermediary generates pooling equilibria that avoid signaling distortions associated with direct selling even under reasonable restrictions on beliefs; these beliefs can also prevent double marginalization by the retailer. Expected profit, consumer surplus and social welfare can all be higher with intermediated selling. However, if secrecy of upstream pricing cannot be maintained, selling through a retailer can only lower the expected profit of the manufacturer.
    Keywords: Asymmetric Information; Product Quality; Delegation, Intermediary, Signaling.
    JEL: L13 L15 D82 D43
    Date: 2020–12
  2. By: ; Joseph E. Stiglitz
    Abstract: The concentration of risk within financial system is considered to be a source of systemic instability. We propose a theory to explain the structure of the financial system and show how it alters the risk taking incentives of financial institutions. We build a model of portfolio choice and endogenous contracts in which the government optimally intervenes during crises. By issuing financial claims to other institutions, relatively risky institutions endogenously become large and interconnected. This structure enables institutions to share the risk of systemic crisis in a privately optimal way, but channels funds to relatively risky investments and creates incentives even for smaller institutions to take excessive risks. Constrained efficiency can be implemented with macroprudential regulation designed to limit the interconnectedness of risky institutions.
    Keywords: Systemic risk; Systemically important financial institutions; Interbank markets; Financial crises; Bailouts; Macroprudential supervision
    JEL: E61 G01 G18 G21 G28
    Date: 2020–12–02
  3. By: Olivier GOSSNER (CNRS – CREST, Institut Polytechnique de Paris and Department of Mathematics, London School of Economics.)
    Abstract: We study the robustness of equilibria with regards to small payoff perturbations of the dynamic game. We show that complete penal codes, that specify players’ strategies after every history, have only limited robustness. We define incomplete penal codes as partial descriptions of equilibrium strategies and introduce a notion of robustness for incomplete penal codes. We prove a Folk Theorem in robust incomplete codes that generates a Folk Theorem in a class of stochastic games.
    Keywords: Repeated games, stochastic games, Folk Theorem, robust equilibrium.
    Date: 2020–12–09
  4. By: Hanming Fang; Zenan Wu
    Abstract: A wealth of evidence shows that individuals are biased and firms can often exploit consumers' behavioral biases in their contract designs. In this paper, we study how vulnerable biased individuals are to their own behavioral biases in market equilibrium, and focus on the role of risk aversion and intertemporal elasticity of substitution (IES). We measure consumer vulnerability by the percentage loss in a consumer's equilibrium certainty equivalent from a market with non-biased consumers to that with biased ones. We examine several important behavioral biases that have been extensively studied in the literature, including the impact of biased beliefs (either over- or under-confidence) in an insurance market, the impact of present bias and naïveté about present bias in a dynamic model of credit contract design, the impact of projection bias about habit formation, and the impact of expectation-based loss aversion on an investor's portfolio choice. We show that consumer vulnerability to all four commonly studied behavioral biases has a non-monotonic relationship with risk aversion or IES. This is in striking contrast to the deviations in the equilibrium allocations from the rational benchmark, which are often monotonic to the risk aversion or IES. We also consider a setting of biased agents with Epstein-Zin preferences to isolate the effect of risk aversion from that of IES.
    JEL: D60 D81 D86 D91
    Date: 2020–11
  5. By: Levy, Daniel; Young, Andrew
    Abstract: We study the cost of breaching an implicit contract in a goods market. Young and Levy (2014) document an implicit contract between the Coca-Cola Company and its consumers. This implicit contract included a promise of constant quality. We offer two types of evidence of the costs of breach. First, we document a case in 1930 when the Coca-Cola Company chose to avoid quality adjustment by incurring a permanently higher marginal cost of production, instead of a one-time increase in the fixed cost. Second, we explore the consequences of the company’s 1985 introduction of “New Coke” to replace the original beverage. Using the Hirschman’s (1970) model of Exit, Voice, and Loyalty, we argue that the public outcry that followed New Coke’s introduction was a response to the implicit contract breach.
    Keywords: Invisible Handshake; Implicit Contract; Customer Market; Long-Term Relationship; Cost of Breaching a Contract; Cost of Breaking a Contract; Coca-Cola; New Coke; Exit Voice and Loyalty; Nickel Coke; Sticky Prices; Rigid Prices; Price Stickiness; Price Rigidity; Cost of Price Adjustment; Menu Cost; Cost of Quality Adjustment
    JEL: E31 K10 L11 L16 L66 M20 M30 N80 N82
    Date: 2020–11–25

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