nep-cta New Economics Papers
on Contract Theory and Applications
Issue of 2021‒04‒12
five papers chosen by
Guillem Roig
University of Melbourne

  1. Guaranteed Markets and Corporate Scientific Research By Sharon Belenzon; Larisa C. Cioaca
  2. Loss Aversion, Moral Hazard, and Stochastic Contracts By Ho, Hoa
  3. On the Optimality of Outsourcing when Vertical Integration can Mitigate Information Asymmetries By Schmitz, Patrick W.
  4. Competitive Nonlinear Pricing under Adverse Selection By Attar, Andrea; Mariotti, Thomas; Salanié, François
  5. Horizontal contracts in a dominant firm-competitive fringe model By Antelo, Manel; Bru, Lluís

  1. By: Sharon Belenzon; Larisa C. Cioaca
    Abstract: Firms invest in scientific research to increase their chances of landing lucrative procurement contracts with the U.S. government. This is an important, but understudied channel through which the government encourages corporate research, particularly when other market mechanisms are insufficient. Using data on $2.3 trillion in contracts matched to 4,323 publicly traded manufacturing firms from 1980 through 2015, we estimate the effect of procurement contracts on upstream (scientific publications) and downstream (patents) corporate R&D. We document a positive effect of contracts on publications, and show that the effect is stronger when market incentives are weak. Procurement contracts encourage publications that: (i) are not used in the firm's internal inventions, (ii) spill over to rivals' inventions, and (iii) are not protected by patents. However, the effect has weakened over time, because the U.S. government has emphasized reduced cost and increased efficiency and transparency in contract awards. Following such policy reforms as the Federal Acquisition Streamlining Act of 1994, the share of R&D contracts in all contracts declined from a high of 25 percent in 1998 to 7 percent in 2015, while the share of commercial contracts grew from 6 percent to 14 percent over the same period. Our results imply that the reorientation of government procurement toward commercially proven technologies has contributed to the withdrawal of corporations from participating in scientific research.
    JEL: O3 O31 O32 O33 O38
    Date: 2021–04
  2. By: Ho, Hoa
    Abstract: I examine whether stochastic contracts benefit the principal in the setting of moral hazard and loss aversion. Incorporating that the agent is expectation-based loss averse and allowing the principal to add noise to performance signals, I find that stochastic contracts reduce the principal's implementation cost in comparison with deterministic contracts. Surprisingly, if performance signals are highly informative about the agent's action, stochastic contracts strictly dominate the optimal deterministic contract for almost any degree of loss aversion. The optimal stochastic contract pays a high wage whenever the principal observes good performance signals, while upon observing bad performance signals it adds a lottery that gives either the high wage or a low wage that serves as a harsh penalty to the agent. In the general case when the agent is both risk and loss averse, I show that if a penalty wage (i.e., a wage level at which the agent feels a substantial disutility) exists, the first best can be approximated closely but not attained. The findings have an important implication for designing contracts for loss-averse agents: the principal should insure the agent against wage uncertainty by employing stochastic contracts that increase the probability of a high wage.
    Keywords: loss aversion; moral hazard; stochastic contracts; reference-dependent preferences
    Date: 2021–03–15
  3. By: Schmitz, Patrick W.
    Abstract: Consider a buyer and a seller who have agreed to trade an intermediate good. It is ex-post efficient to adapt the good to the prevailing state of the world. The seller has private information about the costs of adapting the good. In the case of non-integration, the buyer has no possibility to verify claims that the seller makes about her costs. In the case of vertical integration, the buyer can verify evidence about the costs that the seller might be able to provide. Even though we assume no further differences between the ownership structures, it turns out that the parties may prefer non-integration.
    Keywords: Incomplete contracts; Make-or-buy decision; Property rights approach; Private information; Outsourcing
    JEL: D23 D82 D86 L24 M11
    Date: 2021–03
  4. By: Attar, Andrea; Mariotti, Thomas; Salanié, François
    Abstract: This article surveys recent attempts at characterizing competitive allocations under adverse selection when each informed agent can privately trade with several uninformed parties: that is, trade is nonexclusive. We rst show that requiring market outcomes to be robust to entry selects a unique candidate allocation, which involves cross-subsidies. We then study how to implement this allocation as the equilibrium outcome of a game in which the uninformed parties, acting as principals, compete by making oers to the informed agents. We show that equilibria typically fail to exist in competitive- screening games, in which these oers are simultaneous. We nally explore alternative extensive forms, and show that the candidate allocation can be implemented through a discriminatory ascending auction. These results yield sharp predictions for competitive nonexclusive markets.
    Keywords: Adverse Selection; Entry-Proofness; Discriminatory Pricing; Nonexclusive; Markets; Ascending Auctions
    JEL: D43 D82 D86
    Date: 2021–04
  5. By: Antelo, Manel; Bru, Lluís
    Abstract: This paper offers a rationale for production subcontracting by a market power firm from smaller firms despite the latter’s ability to sell the good for themselves. Particularly, in a dominant firm (DF) model in which the good can be sold through linear pricing or through nonlinear two-part tariff (2PT) contracts, we demonstrate that the DF finds it optimal, whenever it sells its own production plus outsourced production, to subcontract production from fringe firms by setting nonlinear 2PT contracts.
    Keywords: Dominant firm model, linear prices, nonlinear 2PT contracts, horizontal subcontracting, welfare
    JEL: L11 L14
    Date: 2021

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.