|
on Contract Theory and Applications |
|
Issue of 2009‒12‒05
thirteen papers chosen by Simona Fabrizi Massey University Department of Commerce |
| By: | Edmans, Alex; Gabaix, Xavier |
| Abstract: | This paper identifies a class of multiperiod agency problems in which the optimal contract is tractable (attainable in closed form). By modeling the noise before the action in each period, we force the contract to provide sufficient incentives state-by-state, rather than merely on average. This tightly constrains the set of admissible contracts and allows for a simple solution to the contracting problem. Our results continue to hold in continuous time, where noise and actions are simultaneous. We thus extend the tractable contracts of Holmstrom and Milgrom (1987) to settings that do not require exponential utility, a pecuniary cost of effort, Gaussian noise or continuous time. The contract's functional form is independent of the noise distribution. Moreover, if the cost of effort is pecuniary (multiplicative), the contract is linear (log-linear) in output and its slope is independent of the noise distribution, utility function and reservation utility. In a two-stage contracting game, the optimal target action depends on the costs and benefits of the environment, but is independent of the noise realization. |
| Keywords: | closed forms; contract theory; dispersive order; executive compensation; incentives; principal-agent problem; subderivative |
| JEL: | D2 D3 G34 J3 |
| Date: | 2009–11 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7578&r=cta |
| By: | Shaik, Saleem |
| Abstract: | This paper has a two-fold contribution, first we demonstrate the relationship of spatial, temporal and residual yield risk estimated from a two-way panel random effects model to asymmetric information with an optional unit provision in the federal crop insurance program. Second, the yield risk components are incorporated in a discrete choice model to examine the presence of asymmetric information due to potential yield switching with optional unit provisions. Empirical application to 1998 U.S. cotton cro |
| Keywords: | Adverse Selection, Moral Hazard, Optional Unit Policy, Crop Insurance, U.S. Cotton, Crop Production/Industries, Demand and Price Analysis, D82, G22, Q10, |
| Date: | 2009–03 |
| URL: | http://d.repec.org/n?u=RePEc:ags:nddaae:54983&r=cta |
| By: | Megidish, Reut; Sela, Aner |
| Abstract: | We study all-pay contests with an exogenous minimal effort constraint where a player can participate in a contest only if his effort (output) is equal to or higher than the minimal effort constraint. Contestants are privately informed about a parameter (ability) that affects their cost of effort. The designer decides about the size and the number of prizes. We analyze the optimal prize allocation for the contest designer who wishes to maximize either the total effort or the highest effort. It is shown that if the minimal effort constraint is relatively high, the winner-take-all contest in which the contestant with the highest effort wins the entire prize sum does not necessarily maximize the expected total effort nor the expected highest effort. In that case, the random contest in which the entire prize sum is equally allocated to all the participants is a legitimate alternative to the winner-take-all contest. |
| Keywords: | all-pay contests; Participation constraints |
| JEL: | D44 O31 O32 |
| Date: | 2009–11 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7580&r=cta |
| By: | Alex Edmans; Xavier Gabaix |
| Abstract: | This paper identifies a class of multiperiod agency problems in which the optimal contract is tractable (attainable in closed form). By modeling the noise before the action in each period, we force the contract to provide sufficient incentives state-by-state, rather than merely on average. This tightly constrains the set of admissible contracts and allows for a simple solution to the contracting problem. Our results continue to hold in continuous time, where noise and actions are simultaneous. We thus extend the tractable contracts of Holmstrom and Milgrom (1987) to settings that do not require exponential utility, a pecuniary cost of effort, Gaussian noise or continuous time. The contract's functional form is independent of the noise distribution. Moreover, if the cost of effort is pecuniary (multiplicative), the contract is linear (log-linear) in output and its slope is independent of the noise distribution, utility function and reservation utility. In a two-stage contracting game, the optimal target action depends on the costs and benefits of the environment, but is independent of the noise realization. |
| JEL: | D2 G34 J3 |
| Date: | 2009–11 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:15545&r=cta |
| By: | Artashes Karapetyan; Bogdan Stacescu |
| Abstract: | Since information asymmetries have been identified as an important source of bank profits, it may seem that the establishment of information sharing will lead to lower investment in acquiring information. However, banks base their decisions on both hard and soft information, and it is only the former type of data that can be communicated credibly. We show that when hard information is shared, banks will invest more in soft, relationship-specific information. These will lead to more accurate lending decisions, favor small, informationally opaque borrowers, and increase welfare. Since relationship banking focuses on the usage of soft information, the model implies that investment in relationship banking will increase. We test our theory using a large sample of firm-level data from 24 countries. |
| Keywords: | Bank competition, information sharing, relationship banking, hard information, soft information |
| JEL: | G21 L13 |
| Date: | 2009–11 |
| URL: | http://d.repec.org/n?u=RePEc:zur:iewwpx:454&r=cta |
| By: | Jacob K. Goeree; Yuanchuan Lien |
| Abstract: | When goods are substitutes, the Vickrey auction produces efficient, core outcomes that yield competitive seller revenues. In contrast, with complements, the Vickrey outcome, while efficient, is not necessarily in the core and revenue can be very low. Non-core outcomes may be perceived as unfair since there are bidders willing to pay more than the winners' payments. Moreover, non-core outcomes render the auction vulnerable to defections as the seller can attract better offers afterwards. To avoid instabilities of this type, Day and Raghavan (2007) and Day and Milgrom (2007) have suggested to adapt the Vickrey pricing rule. For a simple environment with private information, we show that the resulting auction format yields lower than Vickrey revenues and inefficient outcomes that are on average further from the core than Vickrey outcomes. More generally, we prove that the Vickrey auction is the unique core-selecting auction. Hence, when the Vickrey outcome is not in the core, no Bayesian incentive-compatible core-selecting auction exists. Our results further imply that the competitive equilibrium cannot be implemented when goods are not substitutes. Moreover, even with substitutes, the competitive equilibrium can only be implemented when it coincides with the Vickrey outcome. |
| Keywords: | Core outcomes, Vickrey auction, substitutes, complements, competitive equilibrium, Bayesian implementability |
| JEL: | D44 |
| Date: | 2009–11 |
| URL: | http://d.repec.org/n?u=RePEc:zur:iewwpx:452&r=cta |
| By: | Cornelli, Francesca; Kominek, Zbigniew; Ljungqvist, Alexander P. |
| Abstract: | We test under what circumstances boards discipline managers and whether such interventions improve performance. We exploit exogenous variation due to the staggered adoption of corporate governance laws in formerly Communist countries coupled with detailed ‘hard’ information about the board’s performance expectations and ‘soft’ information about board and CEO actions and the board’s beliefs about CEO competence in 473 mostly private-sector companies backed by private equity funds between 1993 and 2008. We find that CEOs are fired when the company underperforms relative to the board’s expectations, suggesting that boards use performance to update their beliefs. CEOs are especially likely to be fired when evidence has mounted that they are incompetent and when board power has increased following corporate governance reforms. In contrast, CEOs are not fired when performance deteriorates due to factors deemed explicitly to be beyond their control, nor are they fired for making 'honest mistakes.' Following forced CEO turnover, companies see performance improvements and their investors are considerably more likely to eventually sell them at a profit. |
| Keywords: | boards of directors; CEO turnover; Corporate governance; large shareholders; legal reforms; private equity; transition economies |
| JEL: | G24 G32 G34 K22 O16 P21 |
| Date: | 2009–11 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7571&r=cta |
| By: | Montes-Negret, Fernando |
| Abstract: | Liquidity and solvency have been called the"heavenly twins"of banking (Goodhart, Charles,'Liquidity Risk Management', Financial Stability Review -- Special Issue on Liquidity, Banque de France, No. 11, February, 2008). Since these"twins"interact in complex ways, it is difficult -- particularly at times of crisis--to distinguish between them, especially in the presence of information asymmetries (Information asymmetry occurs when one party has more or better information than the other, creating an imbalance of power, giving rise to adverse selection and moral hazard ). An insolvent bank can be liquid or illiquid, and a solvent bank may be at times illiquid. In the latter case, insolvency is not far away, since banking is grounded in information and confidence, and it is confidence which in the end determines liquidity. In other words, liquidity is very much endogenous, determined by the general condition of a bank, as well as the perception of it by the public and market participants. Dealing with liquidity risk is more challenging than dealing with other risks, since liquidity is the result of all the operations of a bank and it is fundamentally a relative concept which compares segments of the balance sheet on the asset and liability sides. It does not deal with absolutes, like arguably the concept of capital and it explains why there is not an internationally recognized"Liquidity Accord". This Working Paper addresses key concepts like market and funding liquidity and basic tools to address liquidity issues like cash flows, liquidity gaps and some selected financial ratios. It aims at providing an introductory guide to risk assessment and management, and provides useful and practical guidelines to undertake liquidity assessments which could prove useful in preparing Financial Assessment Programs (FSAPS) in member countries of the Bretton Woods institutions. |
| Keywords: | Debt Markets,Banks&Banking Reform,Currencies and Exchange Rates,Emerging Markets,Bankruptcy and Resolution of Financial Distress |
| Date: | 2009–11–01 |
| URL: | http://d.repec.org/n?u=RePEc:wbk:wbrwps:5139&r=cta |
| By: | Beker, Pablo (University of Warwick); Subir Chattopadhyay (University of York) |
| Abstract: | We introduce a methodology for analysing infinite horizon economies with two agents, one good, and incomplete markets. We provide an example in which an agent’s equilibrium consumption is zero eventually with probability one even if she has correct beliefs and is marginally more patient. We then prove the following general result: if markets are e?ectively incomplete forever then on any equilibrium path on which some agent’s consumption is bounded away from zero eventually, the other agent’s consumption is zero eventually–so either some agent vanishes, in that she consumes zero eventually, or the consumption of both agents is arbitrarily close to zero infinitely often. Later we show that (a) for most economies in which individual endowments are finite state time homogeneous Markov processes, the consumption of an agent who has a uniformly positive endowment cannot converge to zero and (b) the possibility that an agent vanishes is a robust outcome since for a wide class of economies with incomplete markets, there are equilibria in which an agent’s consumption is zero eventually with probability one even though she has correct beliefs as in the example. In sharp contrast to the results in the case studied by Sandroni (2000) and Blume and Easley (2006) where markets are complete, our results show that when markets are incomplete not only can the more patient agent (or the one with more accurate beliefs) be eliminated but there are situations in which neither agent is eliminated. JEL Codes: D52 ; D61 |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:wrk:warwec:921&r=cta |
| By: | Sergey Stepanov (New Economic School and CEFIR) |
| Abstract: | This paper joins the literature examining connections between legal protection of shareholders and finance. Driven by the need to attract funds a manager tries to reduce agency costs by selling a fraction of equity to a large investor (the outside blockholder). Monitoring by the blockholder can serve as a commitment device limiting inefficient private benefits extraction. However, the threat of collusion between the blockholder and the manager hampers raising funds from dispersed shareholders. We examine how the manager’s choice of the ownership structure is affected by the legal protection of shareholders. Our main finding is that, contrary to the widespread view, there can be a U-shape dependence of the outside ownership concentration on the quality of shareholder protection. At the same time our result on the total ownership concentration is consistent with recent research. |
| Keywords: | Corporate governance, shareholder protection, blockholder monitoring, collusion, ownership structure |
| JEL: | G32 K22 |
| Date: | 2009–11 |
| URL: | http://d.repec.org/n?u=RePEc:cfr:cefirw:w0133&r=cta |
| By: | V. V. Chari; Mikhail Golosov; Aleh Tsyvinski |
| Date: | 2009–12–01 |
| URL: | http://d.repec.org/n?u=RePEc:cla:levarc:814577000000000398&r=cta |
| By: | Christian Ewerhart; Patricia Feubli |
| Abstract: | This paper identifies simple conditions for monotone comparative statics of a unique equilibrium in the Akerlof-Wilson model. Separate conditions apply to trade volume and price. Trade volume increases when supply becomes both stronger and more elastic. In contrast, price decreases when supply becomes both stronger and less elastic. An application to the interbank market suggests surprisingly specific measures to address elevated term rates and market breakdown. |
| Keywords: | Adverse selection, uniqueness of equilibrium, monotone comparative statics, elasticity of supply, log-supermodularity, log-concavity, interbank markets |
| JEL: | D82 G21 |
| Date: | 2009–11 |
| URL: | http://d.repec.org/n?u=RePEc:zur:iewwpx:455&r=cta |
| By: | Maarten Janssen; Paul Pichler; Simon Weidenholzer |
| Abstract: | A large variety of markets, such as retail markets for gasoline or mortgage markets, are characterized by a small number of firms offering a fairly homogenous product at virtually the same cost, while consumers, being uninformed about this cost, sequentially search for low prices. The present paper provides a theoretical examination of this type of market, and confronts the theory with data on retail gasoline prices. We develop a sequential search model with incomplete information and characterize a perfect Bayesian equilibrium in which consumers follow simple reservation price strategies. Firms strategically exploit consumers being uninformed about their production cost, and set on average higher prices compared to the standard complete information model. Thus, consumer welfare is lower. Using data on the gasoline retail market in Vienna (Austria), we further argue that incomplete information is a necessary feature to explain observed gasoline prices within a sequential search framework. |
| JEL: | D40 D83 L13 |
| Date: | 2009–09 |
| URL: | http://d.repec.org/n?u=RePEc:vie:viennp:0914&r=cta |