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on Contract Theory and Applications |
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Issue of 2008‒12‒14
fourteen papers chosen by Simona Fabrizi Massey University Department of Commerce |
| By: | Gary Charness (Department of Economics, University of California, Santa Barbara); Peter Kuhn (Department of Economics, University of California, Santa Barbara); Marie-Claire Villeval (GATE, University of Lyon, CNRS, ENS-LSH, Centre Léon Bérard, France) |
| Abstract: | The ‘ratchet effect’ refers to a situation where a principal uses private information that is revealed by an agent’s early actions to the agent’s later disadvantage, in a context where binding multi-period contracts are not enforceable. In a simple, context-rich environment, we experimentally study the robustness of the ratchet effect to the introduction of ex post competition for principals or agents. While we do observe substantial and significant ratchet effects in the baseline (no competition) case of our model, we find that ratchet behavior is nearly eliminated by labor-market competition; interestingly this is true regardless of whether market conditions favor principals or agents. |
| Keywords: | Ratchet effect, competition, experiment, private information, labor markets |
| JEL: | C91 D23 D82 J24 L14 |
| Date: | 2008 |
| URL: | http://d.repec.org/n?u=RePEc:gat:wpaper:0828&r=cta |
| By: | Hainz , Christa (University of Munich); Weill , Laurent (Université Robert Schuman, Strasbourg); Godlewski, Christophe (University of Strasbourg) |
| Abstract: | We investigate the impact of bank competition on the use of collateral in loan contracts. We develop a theoretical model incorporating information asymmetries in a spatial competition framework where banks choose between screening the borrower and asking for collateral. We show that presence of collateral is more likely when bank competition is low. We then test this prediction empirically on a sample of bank loans from 70 countries. We estimate logit models where the presence of collateral is regressed on bank competition, measured by the Lerner index. Our empirical tests corroborate the theoretical predictions that bank competition reduces the use of collateral. These findings survive several robustness checks. |
| Keywords: | collateral; bank competition; asymmetric information |
| JEL: | D43 D82 G21 |
| Date: | 2008–12–02 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:bofrdp:2008_027&r=cta |
| By: | Jan Myslivecek |
| Abstract: | This paper analyzes markets in which consumers do not directly observe the quality of the products but form their expectations about the quality based on the outcome of voluntary imperfect certification. I analyze how the certification fee impacts the decisions of the producers to apply for a certificate and whether to supply goods of required quality. I find that there are both separating (only high quality producers apply and obtain the certificate) and pooling (both high and low-quality producers apply and obtain) equilibria. I show that the pooling equilibrium exists when the certification fee is low, while the separating equilibrium requires high certification fees. Since the pooling equilibrium is not welfare optimal, excessive competition between certifiers, which lowers the certification fee, is not beneficial. This result complements Strausz (2005) who shows that high certification fees are required to prevent the corruption of the certifier. |
| Keywords: | Certification, Imperfect Testing, Competition,Adverse Selection |
| JEL: | D43 D45 D82 |
| Date: | 2008–09 |
| URL: | http://d.repec.org/n?u=RePEc:cer:papers:wp364&r=cta |
| By: | Robert Dur (Erasmus University Rotterdam, CESifo, and IZA); Joeri Sol (Erasmus University Rotterdam) |
| Abstract: | Social interaction with colleagues is an important job attribute for many workers. To attract and retain workers, managers therefore need to think about how to create and preserve high-quality co-worker relationships. This paper develops a principal-multi-agent model where agents do not only engage in productive activities, but also in social interaction with their colleagues, which in turn creates co-worker altruism. We study how financial incentives for productive activities can improve or damage the work climate. We show that both team incentives and relative incentives can help to create a good work climate. We discuss some empirical evidence supporting these predictions. |
| Keywords: | social interaction; altruism; incentive contracts; co-worker satisfaction |
| JEL: | D86 J41 M50 |
| Date: | 2008–10–02 |
| URL: | http://d.repec.org/n?u=RePEc:dgr:uvatin:20080094&r=cta |
| By: | Giovanni Ferri; Andrea Morone |
| Abstract: | This paper purports to provide some evidence on the effect of rating agencies on herding in financial markets. By means of a laboratory experiment, we investigate the effect and interaction between private and public information. Previous experiments showed that lemmings behaviour can survive in a market context where information is private (Hey and Morone, 2004), and that an experimental market can be very volatile and not efficient in transmitting information (Alfarano et al., 2006). We study experimentally, if socially undesirable behaviour – that survives in a market contest – may be eliminated owing to the presence of rating agencies. |
| Keywords: | Herd behaviour, informational cascades, rating agency, bubble. |
| JEL: | C91 D82 D83 |
| Date: | 2008–10–21 |
| URL: | http://d.repec.org/n?u=RePEc:eei:rpaper:eeri_rp_2008_21&r=cta |
| By: | Dietrich Franz (METEOR) |
| Abstract: | If a group is modelled as a single Bayesian agent, what should its beliefs be? I propose an axiomatic model that connects group beliefs to beliefs of group members, who are themselves modelled as Bayesian agents, possibly with different priors and different information. Group beliefs are proven to take a simple multiplicative form if people''s information is independent, and a more complex form if information overlaps arbitrarily. This shows that group beliefs can incorporate all information spread over the individuals without the individuals having to communicate their (possibly complex and hard-to-describe) private information; communicating prior and posterior beliefs suffices. |
| Keywords: | mathematical economics; |
| Date: | 2008 |
| URL: | http://d.repec.org/n?u=RePEc:dgr:umamet:2008046&r=cta |
| By: | Bertrand Chopard; Thomas Cortade; Eric Langlais |
| Abstract: | Parties engaged in a litigation generally enter the discovery process with different informations regarding their case and/or an unequal endowment in terms of skill and ability to produce evidence and predict the outcome of a trial. Hence, they have to bear different legal costs to assess the (equilibrium) plaintiff’s win rate. The paper analyses pretrial negotiations and revisits the selection hypothesis in the case where these legal expenditures are private information. This assumption is consistent with empirical evidence (Osborne, 1999). Two alternative situations are investigated, depending on whether there exists a unilateral or a bilateral informational asymmetry. Our general result is that efficient pretrial negotiations select cases with the smallest legal expenditures as those going to trial, while cases with largest costs prefer to settle. Under the one-sided asymmetric information assumption, we find that the American rule yields more trials and higher aggregate legal expenditures than the French and British rules. The two-sided case leads to a higher rate of trials, but in contrast provides less clear-cut predictions regarding the influence of fee-shifting. |
| Keywords: | litigation, unilateral and bilateral asymmetric information, legal expenditures |
| JEL: | D81 K42 |
| Date: | 2008 |
| URL: | http://d.repec.org/n?u=RePEc:drm:wpaper:2008-32&r=cta |
| By: | Eric Langlais |
| Abstract: | There is evidence that asymmetric information does exist between litigants: not in a way supporting Bebchuk (1984)’s assumption that defendants’ degree of fault is private information, but more likely as a result of parties’ predictive capacity about the outcome at trial (Osborne, 1999). In this paper, we investigate the incidence of one component of this asymmetric predictive power, which has been examplified in experimental economics. We assume that litigants assess their priors on the plaintiff’s prevailing rate at trial in a way consistent with the self-serving bias, which is the source of the asymmetric information. We compare the predictions of this model regarding the influence of individual priors with those in the literature. Finally, we analyse the influence of another reason for probability distorsion, i.e. risk aversion in the sense of Yaari (1987). |
| Keywords: | litigation, pretrial bargaining, self-serving bias, risk aversion |
| JEL: | D81 K42 |
| Date: | 2008 |
| URL: | http://d.repec.org/n?u=RePEc:drm:wpaper:2008-30&r=cta |
| By: | Dash, Rajdeep K (School of Electronics and Computer Science,University of Southampton); Giovannucci, Andrea (Artificial Intelligence Research Institute, Spanish Council for Scientific Research); Jennings, Nicholas R. (School of Electronics and Computer Science,University of Southampton,); Mezzetti, Claudio (Department of Economics, University of Warwick); Ramchurn, Sarvapali D. (School of Electronics and Computer Science,University of Southampton); Rodriguez-Aguilar, Juan A. (Artificial Intelligence Research Institute, Spanish Council for Scientific Research) |
| Abstract: | Vickrey-Clarke-Groves (VCG) mechanisms are often used to allocate tasks to selfish and rational agents. VCG mechanisms are incentive-compatible, direct mechanisms that are efficient (i.e. maximise social utility) and individually rational (i.e. agents prefer to join rather than opt out). However, an important assumption of these mechanisms is that the agents will always successfully complete their allocated tasks. Clearly, this assumption is unrealistic in many real-world applications where agents can, and often do, fail in their endeavours. Moreover, whether an agent is deemed to have failed may be perceived differently by different agents. Such subjective perceptions about an agent’s probability of succeeding at a given task are often captured and reasoned about using the notion of trust. Given this background, in this paper, we investigate the design of novel mechanisms that take into account the trust between agents when allocating tasks. Specifically, we develop a new class of mechanisms, called trust-based mechanisms, that can take into account multiple subjective measures of the probability of an agent succeeding at a given task and produce allocations that maximise social utility, whilst ensuring that no agent obtains a negative utility. We then show that such mechanisms pose a challenging new combinatorial optimisation problem (that is NP-complete), devise a novel representation for solving the problem, and develop an effective integer programming solution (that can solve instances with about 2×105 possible allocations in 40 seconds). |
| Date: | 2008 |
| URL: | http://d.repec.org/n?u=RePEc:wrk:warwec:880&r=cta |
| By: | Sumit Agarwal; Robert Hauswald |
| Abstract: | Using a unique sample of comparable online and in-person loan transactions, we study the determinants of arm's-length and inside lending focusing on the differential information content across debt types. We find that soft private information primarily underlies relationship lending whereas hard public information drives arm's-length debt. The bank's relative reliance on public or private information in lending decisions then determines trade-offs between the availability and pricing of credit across loan types. Consistent with economic theory, relationship debt leads to informational capture and higher interest rates but is more readily available whereas the opposite holds true for transactional debt. In their choice of loan type, lender switching, and default behavior firms, however, anticipate the inside bank's strategic use of information and act accordingly. |
| Date: | 2008 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedhwp:wp-08-10&r=cta |
| By: | Thomas Crossley (University of Cambridge, London); Mario Jametti (York University, Toronto Canada) |
| Abstract: | Pension benefit guarantee policies have been introduced in several countries to protect private pension plan members from the loss of income that would occur if a plan was underfunded when the sponsoring firm terminates a plan. Most of these public insurance schemes face financial difficulty and consequently policy reforms are being discussed or implemented. Economic theory suggests that such schemes will face moral hazard and adverse selection problems. In this note we test a specific theoretical prediction: insured plans will invest more heavily in risky assets. Our test exploits differences in insurance arrangements across Canadian jurisdictions. We find that insured plans invest about 5 percent more in equities than do similar plans without benefit guarantees. |
| Keywords: | Pensions, benefit guarantee, moral hazard |
| JEL: | G23 G11 C21 |
| Date: | 2008–11 |
| URL: | http://d.repec.org/n?u=RePEc:yca:wpaper:2008_05&r=cta |
| By: | Zhiguo He; Wei Xiong |
| Abstract: | This paper studies optimal contracting in delegated asset management when a fund manager can exert unobservable effort and take unobservable investment positions in multiple markets. A key insight is that while giving the manager flexibility to invest in multiple markets increases investment efficiency, it weakens the link between fund performance and the manager's effort in his designated market, thus increasing agency cost. Building on this tradeoff, our model explains the existence of funds with narrow investment mandates, and provides a set of testable implications for a varying degree of investment flexibility across funds. These results shed light on capital immobility in financial markets, market segmentation, and the architecture of financial institutions. |
| JEL: | G20 |
| Date: | 2008–12 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:14574&r=cta |
| By: | Frantisek Kopriva |
| Abstract: | We focus on the extent of information-driven trading sourced from the behavior of market makers on an emerging market. We develop a methodology based on the Easley et al. (1996) model in order to estimate the extent of informed trading originating from the behavior of Czech market makers on the Prague Stock Exchange (PSE). Based on the high percentage of block trades in the years 2003-05, the market makers focusing on large customers may have a significant source of private information on the PSE. Significant differences in the behavior of market makers lead us to conclude that these differences remarkably affect the extent of information-driven trading. Under current regulation, market makers are able to protect their private information and not reveal it for a surprisingly long period of time. Our study contributes to the detection mechanisms of regulatory authorities on the emerging markets in identifying the suspicious behavior of particular market participants. |
| Keywords: | Trading systems, Informed trading, Emerging markets |
| JEL: | G14 G15 P34 |
| Date: | 2008–09 |
| URL: | http://d.repec.org/n?u=RePEc:cer:papers:wp365&r=cta |
| By: | Michele Fratianni (Department of Business Economics and Public Policy, Indiana University Kelley School of Business) |
| Abstract: | The historical record shows that financial crises are far from being a rare a phenomenon; they occur often enough to be considered part of the workings of finance capitalism. While there is no single hypothesis that can best explain all crises, the implications of the credit boom-and-bust hypothesis, supplemented with asymmetric information, are consistent with the onset and development of many crises, including the current subprime crisis. Governments have reacted to crises by erecting a vast and growing safety net. In turn, to minimize their risk exposure, they have also put in place expansive systems of regulation and supervision. The unwinding of the current crisis will mark a big enlargement of the safety net and moral hazard, as well as a predictable flurry of policy proposals aimed at closing past regulatory loopholes. The maintained hypothesis is that regulatory and market failures are inexorably intertwined. |
| Keywords: | bailout, credit, crisis, money, moral hazard, regulation, safety net, subprime |
| JEL: | E58 F30 G21 N20 |
| Date: | 2008–02 |
| URL: | http://d.repec.org/n?u=RePEc:iuk:wpaper:2008-08&r=cta |