nep-cta New Economics Papers
on Contract Theory and Applications
Issue of 2021‒01‒04
five papers chosen by
Guillem Roig
University of Melbourne

  1. Trust and Contracts: Empirical Evidence By Francesco D'Acunto; Jin Xie; Jiaquan Yao
  2. Optimal sickness benefits in a Principal-Agent Model By Sébastien Ménard
  3. The Allocation OF Talent: Finance versus Entrepreneurship By Kirill Shakhnov
  4. Individual Incentives and Workers’ Contracts: Evidence from a Field Experiment By M. Ali Choudhary; Vasco J. Gabriel; Neil Rickman
  5. Financing Talent Development: The Baseball Reserve System and the Hollywood Star System By Thomas J. Miceli

  1. By: Francesco D'Acunto; Jin Xie; Jiaquan Yao
    Abstract: Trust between parties should drive the negotiation and design of contract: if parties did not trust each others' reaction to unplanned events, they might agree to pay higher costs of negotiation to complete contracts. Using a unique sample of U.S. principal-agent consulting contracts and a negative shock to trust between parties staggered across space and over time, we find that lower trust increases contract completeness. Not only contract complexity but also the verifiable states of the world contracts cover increase after a drop in trust. The results hold for several text-analysis-based measures of completeness and do not arise when agents are also principals (shareholders) or in other falsification tests. Non-compete agreements, confidentiality and indemnification clauses, and restrictions to agents' actions are more likely to be added to contracts signed in the same locations, same industries, and same years after a negative shock to trust.
    Keywords: empirical contract theory, incomplete contracts, cultural economics, beliefs and choice, corporate finance, consulting, textual analysis, non-compete agreements, big five, fraud, accounting, management, organization
    JEL: D86 D91 J33 L14 Z10
    Date: 2020
  2. By: Sébastien Ménard (GAINS - Groupe d'Analyse des Itinéraires et des Niveaux Salariaux - UM - Le Mans Université)
    Abstract: This paper studies the optimal design of sickness benefits in a repeated principal-agent model, where the fraudsters are not observed by the principal. Sickness compensation protects workers against the income fluctuations implied by the risk of illness and its provision is limited by the presence of fraudsters using this protection to temporarily adjust their labour supply. We show that the slope of the optimal contract depends on the dynamics of the rate of fraudsters over time. When the duration of temporary shocks on the disutility of work is shorter than the average duration of diseases, the sickness benefits must increase over time. In addition, A tax dependent on the length of the sick leave makes it possible to minimise the cost for a given promise-keeping constraint. Contrary to intuition, this tax must be decreasing because the necessity to penalise the shortest sick leave to deter agents from cheating.
    Keywords: Sickness benefits,Absence rate,Recursive contracts. JEL: I13,I18,J24
    Date: 2020–11–27
  3. By: Kirill Shakhnov (University of Surrey)
    Abstract: The rapid growth of US financial services coupled with rapid increases in wealth inequality have been focusing policy debate as to the function of the financial sector and on its social desirability as a whole. I propose a heterogeneous agent model with asymmetric information and matching frictions that produces a tradeoff between finance and entrepreneurship. By becoming bankers, talented agents efficiently match investors with entrepreneurs, but extract excessive informational rents due to contract incompleteness. Thus the financial sector is inefficiently large in equilibrium, and this inefficiency increases with wealth inequality. The estimated model accounts for the simultaneous growth of wealth inequality and the financial sector in the US. The endogenous feedback between inequality and the size of the financial sector is quantitatively important.
    JEL: E44 E24 G14 L26
    Date: 2020–12
  4. By: M. Ali Choudhary (State Bank of Pakistan); Vasco J. Gabriel (University of Surrey and NIPE-UM); Neil Rickman (University of Surrey)
    Abstract: We present evidence on the operation of incentive pay from a field experiment in Pakistan, looking at piece rates and pay based on rank achieved in a tournament. Importantly, some workers are in contracts ‘tying’ them to the employer for several picking seasons; others are ‘untied’ in the sense of being employed for only the current season. We find that incentive pay (of either type) improves productivity by 30% on average, but that there are important differences across the types of workers: in particular, tournament incentives are less effective amongst the tied workers. We suggest that our main results have implications for tournament theory and the design of incentive pay schemes, particularly to the extent that they may discourage some workers and, thus, reduce incentives.
    JEL: D23 J23 J33 M52
    Date: 2020–10
  5. By: Thomas J. Miceli (University of Connecticut)
    Abstract: This paper examines contractual arrangements that once governed employment relationships in two prominent entertainment industries: professional baseball and Hollywood filmmaking. The arrangements were, respectively, the player reserve system and the star system. Both were defended as necessary by the governing powers of each industry, but both were also criticized as exploitive of employees because they prevented them from negotiating as free agents with other possible employers. The argument in this paper is that these systems can be interpreted as having served a rational economic purpose; namely, to promote efficient investment in the development of would-be performers in professions where the probability of success is very low. The persistence of a limited reserve period in baseball in the presence of a strong players’ union is evidence for this claim. By contrast, the demise of the star system reflects the diminished importance of talent development by studios. JEL Classification: J30, J41, J42, J53, L14, L82 Key words: Reserve system, star system, training, incentive contracts
    Date: 2020–12

This nep-cta issue is ©2021 by Guillem Roig. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.