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on Contract Theory and Applications |
| By: | Prat, Julien (IAE Barcelona (CSIC)); Jovanovic, Boyan (New York University) |
| Abstract: | We analyze a long-term contracting problem involving common uncertainty about a parameter capturing the productivity of the relationship, and featuring a hidden action for the agent. We develop an approach that works for any utility function when the parameter and noise are normally distributed and when the effort and noise affect output additively. We then analytically solve for the optimal contract when the agent has exponential utility. We find that the Pareto frontier shifts out as information about the agent's quality improves. In the standard spot-market setup, by contrast, when the parameter measures the agent's "quality", the Pareto frontier shifts inwards with better information. Commitment is therefore more valuable when quality is known more precisely. Incentives then are easier to provide because the agent has less room to manipulate the beliefs of the principal. Moreover, in contrast to results under one-period commitment, wage volatility declines as experience accumulates. |
| Keywords: | principal-agent model, optimal contract, learning, private information, reputation, career |
| JEL: | D82 D83 E24 J41 |
| Date: | 2010–11 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp5323&r=cta |
| By: | Michi NISHIHARA (Graduate School of Economics, Osaka University); Takashi SHIBATA (Graduate School of Social Sciences, Tokyo Metropolitan University, Statistical Laboratory, University of Cambridge) |
| Abstract: | This paper investigates a principal-agent model in which an owner (principal) optimizes a contract with a manager (agent) delegated to undertake an investment project. In the model, we explore the effects of costly exploration by which the manager learns the real value of development cost. We show that high exploration cost can lead to a pooling policy not contingent on project type. Further, and more notably, we show that, in the presence of asymmetric information, higher exploration cost leads to wealth transfer from owner to manager and can then play a positive role in preventing a greedy contract by the owner and improving social welfare. |
| Keywords: | Real Options; Asymmetric Information; Costly Learning; Sequential Investment; Incentive Theory |
| JEL: | D86 G13 G31 |
| Date: | 2010–11 |
| URL: | http://d.repec.org/n?u=RePEc:osk:wpaper:1027&r=cta |
| By: | Daniel Danau; Annalisa Vinella |
| Abstract: | We study the screening problem that arises in a framework where, initially, the agent is privately informed about both the expected production cost and the cost variability and, at a later stage, he learns privately the cost realization. The specifi?c set of relevant incentive constraints, and so the characteristics of the optimal mechanism, depend ?finely upon the curvature of the principal's marginal surplus function as well as the relative importance of the two initial information problems. Pooling of production levels is optimally induced with respect to the cost variability when the principal's knowledge imperfection about the latter is sufficiently less important than that about the expected cost. |
| Keywords: | Cost uncertainty; Multidimensional screening; Sequential screening |
| JEL: | D81 D82 D86 |
| Date: | 2010–07 |
| URL: | http://d.repec.org/n?u=RePEc:san:crieff:1007&r=cta |
| By: | Artashes Karapetyan (Norges Bank (Central Bank of Norway)); Bogdan Stacescu (Norwegian School of Management (BI)) |
| Abstract: | Since information asymmetries have been identified as an important source of bank profits, it may seem that the establishment of information sharing (e.g., introducing credit bureaus or public registers) 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 information. These will produce more accurate lending decisions, provide higher welfare, lead to an increased focus on relationship banking and favor informationally opaque borrowers. We test our theory using a large sample of firm-level data from 24 countries. |
| Keywords: | Bank competition, information sharing, relationship bank, hard, soft |
| JEL: | G21 L13 |
| Date: | 2010–11–25 |
| URL: | http://d.repec.org/n?u=RePEc:bno:worpap:2010_24&r=cta |
| By: | Schnedler, Wendelin |
| Abstract: | Incentives often fail in inducing economic agents to engage in a desirable activity; implementability is restricted. What restricts implementability? When does re-organization help to overcome this restriction? This paper shows that any restriction of implementability is caused by an identification problem. It also describes organizations that can solve this identification problem and provides conditions under which such organisations exist. Applying the findings to established and new moral hazard models yields insights into optimal organization design, uncovers the reason why certain organization designs, such as advocacy or specialization, overcome restricted implementability, and formalizes a wide-spread type of multi-tasking problem. |
| Keywords: | moral hazard; hidden action; implementation; multi-tasking; identification by organization design |
| Date: | 2010–11–26 |
| URL: | http://d.repec.org/n?u=RePEc:awi:wpaper:0505&r=cta |
| By: | Schnedler, Wendelin (University of Heidelberg) |
| Abstract: | Incentives often fail in inducing economic agents to engage in a desirable activity; implementability is restricted. What restricts implementability? When does re-organization help to overcome this restriction? This paper shows that any restriction of implementability is caused by an identification problem. It also describes organizations that can solve this identification problem and provides conditions under which such organisations exist. Applying the findings to established and new moral hazard models yields insights into optimal organization design, uncovers the reason why certain organization designs, such as advocacy or specialization, overcome restricted implementability, and formalizes a wide-spread type of multi-tasking problem. |
| Keywords: | moral hazard, hidden action, implementation, multi-tasking, identification by organization design |
| JEL: | D86 M52 J33 D82 M41 |
| Date: | 2010–11 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp5325&r=cta |
| By: | Sophie Bade (Max Planck Institute for Research on Collective Goods, Bonn) |
| Abstract: | The paper introduces the assumption of costly information acquisition to the theory of mechanism design for matching allocation problems. It is shown that the assumption of endogenous information acquisition greatly changes some of the cherished results in that theory: in particular, the first-best might not be implementable. Moreover, it might not even be possible to implement the second-best through trade. In addition, the paper highlights the use of randomness in setting incentives for efficient learning. The trade-offs among simultaneous and sequential learning and among efficient learning and efficient allocations are discussed. |
| Keywords: | Bubbles, Rational Expectations, Bonuses, Compensation Schemes, Financial Crises, Financial Policy |
| JEL: | C78 |
| Date: | 2010–11 |
| URL: | http://d.repec.org/n?u=RePEc:mpg:wpaper:2010_46&r=cta |
| By: | Eva I. Hoppe; David J. Kusterer |
| Abstract: | We study a multi-task principal-agent problem in which tasks can be in direct conflict with each other. In theory, it is difficult to induce a single agent to exert efforts in two conflicting tasks, because effort in one task decreases the success probability of the other task. We have conducted an experiment in which we find strong support for the relevance of this incentive problem. In the presence of conflict, subjects choose two efforts significantly less often when both tasks are assigned to a single agent than when there are two agents each in charge of one task. |
| Keywords: | moral hazard, conflicting tasks, experiment |
| JEL: | D86 C90 M54 |
| Date: | 2010–08–24 |
| URL: | http://d.repec.org/n?u=RePEc:cgr:cgsser:01-04&r=cta |
| By: | Luciano Fanti; Nicola Meccheri |
| Abstract: | This paper studies equilibrium incentive contracts in a Cournot duopoly, in which institutional arrangements constrain firms to pay (risk-neutral) workers a given salary. In this context, performance-related-pay (PRP) and relative performance evaluation (RPE) are compared in terms of resulting levels of workers’ effort (firms’ expected output), market price, profits, consumer surplus and social welfare. It is shown that, while under principal-agent standard assumptions (i.e. all wage components are “freely” negotiated by each firm-worker pair) PRP and RPE are equivalent, in the presence of institutional “frictions”, RPE outperforms PRP in relation to output, profits, consumer surplus and social welfare. Moreover, RPE also permits to replicate results obtained without institutional constraints, even if the mechanism driving final outcomes is very different. |
| Keywords: | Cournot duopoly, principal-agent model, relative performance evaluation, institutional constraints. |
| JEL: | J33 J41 L13 |
| Date: | 2010–09–10 |
| URL: | http://d.repec.org/n?u=RePEc:pie:dsedps:2010/103&r=cta |
| By: | Luciano Fanti (Department of Economics, University of Pisa, Italy); Nicola Meccheri (Department of Economics, University of Pisa, Italy; The Rimini Centre for Economic Analysis (RCEA), Italy) |
| Abstract: | This paper studies equilibrium incentive contracts in a Cournot duopoly, in which institutional arrangements constrain firms to pay (risk-neutral) workers a given salary. In this context, performance-related-pay (PRP) and relative performance evaluation (RPE) are compared in terms of resulting levels of workers' effort (firms' expected output), market price, profits, consumer surplus and social welfare. It is shown that, while under principal-agent standard assumptions (i.e. all wage components are "freely" negotiated by each firm-worker pair) PRP and RPE are equivalent, in the presence of institutional "frictions", RPE outperforms PRP in relation to output, profits, consumer surplus and social welfare. Moreover, RPE also permits to replicate results obtained without institutional constraints, even if the mechanism driving final outcomes is very different. |
| Keywords: | Cournot duopoly, principal-agent model, relative performance evaluation, institutional constraints |
| JEL: | J33 J41 L13 |
| Date: | 2010–01 |
| URL: | http://d.repec.org/n?u=RePEc:rim:rimwps:38_10&r=cta |
| By: | Christoph Kuzmics; Brian W. Rogers |
| Date: | 2010–11–22 |
| URL: | http://d.repec.org/n?u=RePEc:cla:levarc:661465000000000332&r=cta |
| By: | Nicola Meccheri (Department of Economics, University of Pisa, Italy; The Rimini Centre for Economic Analysis (RCEA), Italy); Luciano Fanti (Department of Economics, University of Pisa, Italy) |
| Abstract: | This paper studies the interaction between incentive labour contracts, competition à la Cournot and industry profits, in a context where workers’ effort is not verifiable and the probability of the unemployed getting a job can depend on their employment histories according to the degree of product market competition. It is shown that efficiency wages paid by each firm can decrease when competition becomes fiercer. With discretionary bonuses, instead, wages are generally uncorrelated with competition, but there exists an upper threshold for the number of competing firms, over which profits collapse to zero. Moreover, if information about firms’ misbehaviour in paying bonuses flows in the labour market at a low rate, firms can make positive profits only by paying efficiency wages. |
| Keywords: | industry profits, Cournot competition, efficiency wages, performance pay |
| JEL: | J33 J41 L13 |
| Date: | 2010–01 |
| URL: | http://d.repec.org/n?u=RePEc:rim:rimwps:37_10&r=cta |
| By: | Tymofiy Mylovanov (Penn State University); Andriy Zapechelnyuk (Queen Mary, University of London) |
| Abstract: | This paper studies optimal decision rules for a decision maker who can consult two experts in an environment without monetary payments. This extends the previous work by Holmström (1984) and Alonso and Matouschek (2008) who consider environments with one expert. In order to derive optimal decision rules, we prove a "constant-threat" result that states that any out-of-equilibrium pair of recommendations by the experts are punished with an action that is independent of their reports. A particular property of an optimal decision rule is that it is simple and constant for a large set of experts' preferences and distribution of their private information. Hence, it is robust in the sense that it is not affected by errors in specifying these features of the environment. By contrast, the constructions of optimal outcomes absent commitment or with only one expert are sensitive to model details. |
| Keywords: | Communication, Information, Noise, Experts, Constant threat |
| JEL: | C72 D82 D83 |
| Date: | 2010–11 |
| URL: | http://d.repec.org/n?u=RePEc:qmw:qmwecw:wp674&r=cta |
| By: | Cesaroni, Giovanni |
| Abstract: | The work discusses a basic proposition in the theory of competition in markets with adverse selection (Bester, 1985). By working out the sequence of market transactions, we show that the effectiveness of collateral in avoiding equilibrium rationing depends on an assumption of uncontestability of the loan market. If contestability is restored to its proper place, the separation of borrower by means of sufficient collateral does not impede the emergence of credit rationing, which results from a coordination failure among risk-neutral banks. As a consequence, even in a risk-neutral environment with suitable endowments, the use of collateral in credit contracts could not be a socially efficient screening-device. Our conclusion on rationing does not stand in contrast with the general result of Gale (1996). |
| Keywords: | Adverse selection; Collateral; Rationing; Contestable markets; |
| JEL: | L10 D82 G21 |
| Date: | 2010–10–11 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:26949&r=cta |
| By: | Alexey I. Kushnir |
| Date: | 2010–11–22 |
| URL: | http://d.repec.org/n?u=RePEc:cla:levarc:661465000000000351&r=cta |
| By: | Propper, Carol; von Hinke Kessler Scholder, Stephanie; Tominey, Emma; Ratto, Marisa; Burgess, Simon |
| Abstract: | We use an experiment to study the impact of team-based incentives, exploiting rich data from personnel records and management information systems. Using a triple difference design, we show that the incentive scheme had an impact on team performance, even with quite large teams. We examine whether this effect was due to increased effort from workers or strategic task reallocation. We find that the provision of financial incentives did raise individual performance but that managers also disproportionately reallocated efficient workers to the incentivised tasks. We show that this reallocation was the more important contributor to the overall outcome. |
| Keywords: | Public Sector; Incentives; Performance; Teams; |
| JEL: | J33 J38 |
| Date: | 2010 |
| URL: | http://d.repec.org/n?u=RePEc:ner:dauphi:urn:hdl:123456789/4727&r=cta |
| By: | Danthine, Jean-Pierre (Swiss National Bank); Donaldson, John B. (School of Business, Columbia University) |
| Abstract: | We study the dynamic general equilibrium of an economy where risk averse shareholders delegate the management of the firm to risk averse managers. The optimal contract has two main components: an incentive component corresponding to a non-tradable equity position and a variable “salary” component indexed to the aggregate wage bill and to aggregate dividends. Tying a manager’s compensation to the performance of her own firm ensures that her interests are aligned with the goals of firm owners and that maximizing the discounted sum of future dividends will be her objective. Linking managers’ compensation to overall economic performance is also required to make sure that managers use the appropriate stochastic discount factor to value those future dividends. General equilibrium considerations thus provide a potential resolution of the “pay for luck” puzzle. We also demonstrate that one sided “relative performance evaluation” follows equally naturally when managers and shareholders are differentially risk averse. |
| Keywords: | incentives; optimal contracting; stochastic discount factor; pay-for-luck; relative performance |
| JEL: | E32 E44 |
| Date: | 2010–09–17 |
| URL: | http://d.repec.org/n?u=RePEc:ris:snbwpa:2010_019&r=cta |