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on Contract Theory and Applications |
| By: | Rupert Sausgruber (Department of Economics, Copenhagen University); Christoph Schotmüller (Department of Economics, Tilburg University) |
| Abstract: | We study a monopoly insurance model with endogenous information acquisition. Through a continuous effort choice, consumers can determine the precision of a privately observed signal that is informative about their accident risk. The equilibrium effort is, depending on parameter values, either zero (implying symmetric information) or positive (implying privately informed consumers). Regardless of the nature of the equilibrium, all offered contracts, also at the top, involve underinsurance. The reason is that underinsurance at the top discourages information gathering. We identify a sorting effect that explains why the insurer wants to discourage information acquisition. Moreover, a public policy that decreases the information gathering costs can hurt both parties. Lower information gathering costs can harm consumers because the insurer adjusts the optimal contract menu in an unfavorable manner. |
| Keywords: | asymmetric information, information acquisition, insurance, screening, adverse selection |
| JEL: | D82 I13 |
| Date: | 2013–11–26 |
| URL: | http://d.repec.org/n?u=RePEc:kud:kuiedp:1315&r=cta |
| By: | Johan N. M. Lagerlöf (Department of Economics, Copenhagen University); Christoph Schottmüller (Department of Economics, Tilburg University) |
| Abstract: | What are the welfare effects of a policy that facilitates for insurance customers to privately and covertly learn about their accident risks? We endogenize the information structure in Stiglitz's classic monopoly insurance model. We first show that his results are robust: For a small information acquisition cost c, the consumer gathers information and the optimal contracts are close to the ones in the Stiglitz model. If c is so low that the consumer already gathers information (c c*, marginally reducing c hurts the insurer and weakly benefits the consumer. Paradoxically, a reduction in c that is "successful," meaning that the consumer gathers information after the reduction but not before it, can hurt both parties. The reasons for this are that, after the reduction, (i) the cost is actually incurred and (ii) the contracts can be more distorted. |
| Keywords: | asymmetric information, information acquisition, insurance, screening, adverse selection |
| JEL: | D82 I13 |
| Date: | 2013–11–11 |
| URL: | http://d.repec.org/n?u=RePEc:kud:kuiedp:1312&r=cta |
| By: | Clausen, Andrew |
| Abstract: | In many moral hazard problems, the principal evaluates the agent's performance based on signals which the agent may suppress and replace with counterfeits. This form of fraud may affect the design of optimal contracts drastically, leading to complete market failure in extreme cases. I show that in optimal contracts, the principal deters all fraud, and does so by two complementary mechanisms. First, the principal punishes signals that are suspicious, i.e. appear counterfeit. Second, the principal is lenient on bad signals that the agent could suppress, but does not. |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:edn:sirdps:442&r=cta |
| By: | Bertola, Giuseppe (EDHEC Business School); Koeniger, Winfried (University of St. Gallen) |
| Abstract: | We consider an economy where individuals privately choose effort and trade competitively priced securities that pay off with effort-determined probability. We show that if insurance against a negative shock is sufficiently incomplete, then standard functional form restrictions ensure that individual objective functions are optimized by an effort and insurance combination that is unique and satisfies first- and second-order conditions. Modeling insurance incompleteness in terms of costly production of private insurance services, we characterize the constrained inefficiency arising in general equilibrium from competitive pricing of nonexclusive financial contracts. |
| Keywords: | hidden action, principal agent, first-order approach, constrained efficiency |
| JEL: | E21 D81 D82 |
| Date: | 2013–12 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp7806&r=cta |
| By: | Stenzel, A.; Wagner, W.B. (Tilburg University, Center for Economic Research) |
| Abstract: | Abstract: We consider a model of private information acquisition in which the cost of information depends on an asset's opacity. The model generates a hump-shaped relationship between opacity and the equilibrium amount of private information. In particular, the incentives to acquire information are largest for assets of intermediate opacity; such assets hence display low liquidity in the secondary market due to adverse selection. We also show that costly information acquisition generates incentives to source more correlated assets in the economy, as correlation reduces duplication of information costs. Our ndings have implications for the design of nancial regulation which aim at promoting transparency and reducing correlation in the fi nancial system. |
| Keywords: | endogenous information acquisition;opacity;asset liquidity |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:dgr:kubcen:2013066&r=cta |
| By: | Xiao Yu Wang |
| Abstract: | This note identifies a moral hazard environment in which a piecewise linear compensation scheme is optimal. Both the principal and the agent have CARA utility, mean output is increasing in the agent's non-contractible input, and output is distributed according to a Laplace distribution, which resembles a normal distribution (e.g. it is symmetric about the mean), but has fatter tails. The key property of the Laplace distribution is that the likelihood ratio is a piecewise constant, where the discontinuity occurs at the mean. The value of this approach is twofold: First, a tractable, empirically-observed wage scheme emerges as the equilibrium in a simple static contracting model. Second, the optimal piecewise linear scheme cleanly separates insurance and incentive provision. The linearity at output levels away from the mean captures insurance, while the jump at the mean captures incentive provision. Hence, this model is well-suited for studying a wide variety of principal-agent problems in risky environments subject to moral hazard, such as the effect of risk and moral hazard considerations on employment relationships in developing economies. |
| Keywords: | principal agent problems, moral hazard, linear incentive schemes, insurance, incentives |
| JEL: | C70 D86 O12 |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:duk:dukeec:13-23&r=cta |
| By: | Kohei, Kawamura |
| Abstract: | This paper studies information transmission between an uninformed decision maker (receiver) and an informed player (sender) who have asymmetric beliefs ("con fidence") on the sender s ability ("competence") to observe the state of nature. We fi nd that even when the material payoffs of are perfectly aligned, the sender s over- and underconfi dence on his information give rise to information loss in communication, although they do not by themselves completely eliminate information transmission in equilibrium. However, an underconfi dent sender may prefer no communication to informative communication. We also show that when the sender is biased, overconfi dence can lead to more information transmission and welfare improvement. |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:edn:sirdps:470&r=cta |
| By: | Michèle Belot (University of Edinburgh) Jeroen van de Ven (Amsterdam Center for Law and Economics, University of Amsterdam, and Tinbergen Institute) |
| Abstract: | We provide experimental evidence on the ability to detect deceit in a buyer-seller game with asymmetric information. Sellers have private information about the buyer’s valuation of a good and sometimes have incentives to mislead buyers. We examine if buyers can spot deception in face-to-face encounters. We vary (1) whether or not the buyer can interrogate the seller, and (2) the contextual richness of the situation. We find that the buyers’ prediction accuracy is above chance levels, and that interrogation and contextual richness are important factors determining the accuracy. These results show that there are circumstances in which part of the information asymmetry is eliminated by people’s ability to spot deception. |
| Keywords: | Deception, lie detection, asymmetric information, face-to-face interaction, experiment. |
| JEL: | C91 D82 K4 |
| Date: | 2013–12–19 |
| URL: | http://d.repec.org/n?u=RePEc:edn:esedps:237&r=cta |
| By: | Kohei, Kawamura; Vasileios, Vlaseros |
| Abstract: | This paper studies dichotomous majority voting in common interest committees where each member receives not only a private signal but also a public signal observed by all of them. The public signal represents, e.g. expert information presented to an entire committee and its quality is higher than that of each individual private signal. We identify two informative symmetric strategy equilibria, namely i) the mixed strategy equilibrium where each member randomizes between following the private and public signals should they disagree; and ii) the pure strategy equilibrium where they follow the public signal for certain. The former outperforms the latter. The presence of the public signal precludes the equilibrium where every member follows their own signal, which is an equilibrium in the absence of the public signal. The mixed strategy equilibrium in the presence of the public signal outperforms the sincere voting equilibrium without the public signal, but the latter may be more efficient than the pure strategy equilibrium in the presence of the public signal. We suggest that whether expert information improves committee decision making depends on equilibrium selection. |
| Keywords: | information aggregation, strategic voting, expert information, |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:edn:sirdps:446&r=cta |
| By: | Johannes Horner (Cowles Foundation, Yale University); Satoru Takahashi (National University of Singapore); Nicolas Vieille (HEC Paris) |
| Abstract: | This paper characterizes an equilibrium payoff subset for Markovian games with private information as discounting vanishes. Monitoring is imperfect, transitions may depend on actions, types be correlated and values interdependent. The focus is on equilibria in which players report truthfully. The characterization generalizes that for repeated games, reducing the analysis to static Bayesian games with transfers. With correlated types, results from mechanism design apply, yielding a folk theorem. With independent private values, the restriction to truthful equilibria is without loss, except for the punishment level; if players withhold their information during punishment-like phases, a "folk" theorem obtains also. |
| Keywords: | Bayesian games, Repeated games, Folk theorem |
| JEL: | C72 C73 |
| Date: | 2013–12 |
| URL: | http://d.repec.org/n?u=RePEc:cwl:cwldpp:1933&r=cta |
| By: | OKADA, Akira |
| Abstract: | We consider a non-cooperative two-person sequential bargaining game with incomplete information. Player types are verifiable when a con-tract is implemented. We show that there is no delay in agreements and the inscrutability principle holds under the property of independence of irrelevant types (IIT), whereby the response of every type of player is independent of proposals to other player types. We prove the existence of a stationary sequential equilibrium satisfying IIT and a self-selection property for every discount factor for future payoffs. We also show that the equilibrium proposal of every player converges to the ex post Nash bargaining solution as the discount factor goes to one. |
| Keywords: | bargaining, incomplete information, mechanism selection, ex post Nash bargaining solution, non-cooperative games |
| JEL: | C72 C78 D82 |
| Date: | 2013–12 |
| URL: | http://d.repec.org/n?u=RePEc:hit:econdp:2013-15&r=cta |
| By: | Diasakos, Theodoros M; Koufopoulos, Kostas |
| Abstract: | This paper revisits the problem of adverse selection in the insurance market of Rothschild and Stiglitz [28]. We propose a simple extension of the game-theoretic structure in Hellwig [14] under which Nash-type strategic interaction between the informed customers and the uninformed firms results always in a particular separating equilibrium. The equilibrium allocation is unique and Pareto-efficient in the interim sense subject to incentive-compatibility and individual rationality. In fact, it is the unique neutral optimum in the sense of Myerson [22]. |
| Keywords: | Insurance Market, Adverse Selection, Incentive Efficiency, |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:edn:sirdps:509&r=cta |
| By: | Chatterji, S.; Ghosal, S. |
| Abstract: | Bank crises, by interrupting liquidity provision, have been viewed as resulting in welfare losses. In a model of banking with moral hazard, we show that second best bank contracts that improve on autarky ex ante require costly crises to occur with positive probability at the interim stage. When bank payoffs are partially appropriable, either directly via imposition of fines or indirectly by the use of bank equity as a collateral, we argue that an appropriately designed ex-ante regime of policy intervention involving conditional monitoring can prevent bank crises. |
| Keywords: | bank runs, contagion, moral hazard, liquidity, random, contracts, monitoring, |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:edn:sirdps:521&r=cta |
| By: | Sourav Bhattacharya; Maria Goltsman; Arijit Mukherjee |
| Abstract: | We consider a persuasion game between a decision-maker and a panel of biased experts. The decision-maker prefers to take an action in [0, 1] that matches the underlying state but relies on the experts to learn the state. Each expert has his `ideal` action or `agenda` and may conceal unfavorable information. If the decision- maker can select the panel members based on their agendas, what panel would she choose? While common intuition favors diverse panel (as experts would restrict each other`s ability to alter information), Bhattacharya and Mukherjee (2013) presents an example where a `homogeneous` panel (either all have agenda 0, or all have agenda 1) is more conducive to information revelation than a `diverse` panel (where one expert`s agenda is 0 the other`s is 1). We analyze the optimal diversity in expert panels and show that under mild conditions, a homogeneous panel is optimal when the experts observe the state independently of each other. But if the observability of the state is correlated across experts, diverse panel may be optimal. Hence, the diversity of agendas must be considered in conjunction with the diversity of information sources, and it is never optimal to seek diversity in both dimensions. |
| Date: | 2013–01 |
| URL: | http://d.repec.org/n?u=RePEc:pit:wpaper:516&r=cta |
| By: | Sourav Bhattacharya; Paulo Barelli |
| Abstract: | We provide a simple condition that is both necessary and sufficient for aggregation of private information in large elections where all voters have the same preference. In some states of the world, all voters prefer A; and in other states, all voters prefer B. Each voter draws a private signal independently from a distribution conditional on the state. According to our condition, there should be a hyperplane in the simplex over signals that separates the conditional distributions in states where A is preferred from those in states where B is preferred. If this condition is satisfied, information is aggregated in an equilibrium sequence: even under incomplete information, the preferred outcome obtains almost surely in each state. If the hyperplane condition is violated, there exists no feasible strategy profile that aggregates information. Therefore, information aggregation holds only for special environments. |
| Date: | 2013–12 |
| URL: | http://d.repec.org/n?u=RePEc:pit:wpaper:515&r=cta |
| By: | Moore, John; Ye, Michelle (Mingxiao) |
| Abstract: | Adverse selection may thwart trade between an informed seller, who knows the probability p that an item of antiquity is genuine, and an uninformed buyer, who does not know p. The buyer might not be wholly uninformed, however. Suppose he can perform a simple inspection, a test of his own: the probability that an item passes the test is g if the item is genuine, but only f < g if it is fake. Given that the buyer is no expert, his test may have little power: f may be close to g. Unfortunately, without much power, the buyer's test will not resolve the difficulty of adverse selection; gains from trade may remain unexploited. But now consider a "store", where the seller groups a number of items, perhaps all with the same quality, the same probability p of being genuine. (We show that in equilibrium the seller will choose to group items in this manner.) Now the buyer can conduct his test across a large sample, perhaps all, of a group of items in the seller's store. He can thereby assess the overall quality of these items; he can invert the aggregate of his test results to uncover the underlying p; he can form a "prior". There is thus no longer asymmetric information between seller and buyer: gains from trade can be exploited. This is our theory of retailing: by grouping items together - setting up a store - a seller is able to supply buyers with priors, as well as the items themselves. We show that the weaker the power of the buyer�s test (the closer f is to g), the greater the seller�s profit. So the seller has no incentive to assist the buyer � e.g., by performing her own tests on the items, or by cleaning them to reveal more about their true age. The paper ends with an analysis of which sellers should specialise in which qualities. We show that quality will be low in busy locations and high in expensive locations. |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:edn:sirdps:497&r=cta |
| By: | Tsuyoshi Takahara |
| Abstract: | We analyze the rationale for official authorization of patient dumping in the prospective-payment policy framework. We show that when the insurer designs the healthcare payment policy to let hospitals dump high-cost patients, there is a trade-off between the disutility of dumped patients (changes in hospitals' rent extracting due to low-severity patients) and the shift in the cost-reduction effort level for high-severity patients. We also clarify the welfare-improving conditions by allowing hospitals to dump high-severity patients. Finally, we show that if the efficiency of the cost-reduction effort varies by much and the healthcare payment cost is large, or if there exist many private hospitals, the insurer can improve social welfare in a wider environment. |
| Date: | 2013–12 |
| URL: | http://d.repec.org/n?u=RePEc:dpr:wpaper:0891&r=cta |
| By: | Nadine Leonhardt |
| Abstract: | The present paper explicitly models the principal-agent relationship between a democratic population and its elected representative within a standard war bargaining setup. I fi nd that the specific structure of this relationship and the problems resulting from it help overcome information asymmetries in crisis bargaining. This provides an alternative theoretic explanation of democracies‘ signaling advantage which may turn out to be more realistic than the concept of audience costs. |
| Keywords: | Democratic peace; principal-agent problems; crisis bargaining |
| JEL: | C78 D74 J52 |
| Date: | 2013–11 |
| URL: | http://d.repec.org/n?u=RePEc:rwi:repape:0453&r=cta |
| By: | Dmitry Lubensky (Department of Business Economics and Public Policy, Indiana University Kelley School of Business) |
| Abstract: | Consumers rely on a manufacturer's recommended price to help determine whether to accept a retailer's price or continue to search. This paper demonstrates that doing so can be rational even if the manufacturer's price recommendation is cheap talk. By incentivizing search, a manufacturer trades off reducing double marginalization and losing consumers to competitors. When the manufacturer's cost is low he induces low retail prices and benefits when consumers search more. When the manufacturer's cost is high he induces high retail prices and benefits when consumers search less. Since consumers prefer to search more when lower prices are available, their incentives are aligned with the manufacturer's and this allows informative cheap talk communication. Aside from costs, the manufacturer can inform consumers of other market parameters such as product quality. |
| Keywords: | consumer search, sequential search, search with uncertainty, manufacturer suggested retail prices, vertical markets, signaling, cheap talk |
| JEL: | L11 D82 |
| Date: | 2013–12 |
| URL: | http://d.repec.org/n?u=RePEc:iuk:wpaper:2013-14&r=cta |
| By: | Duprey , T. |
| Abstract: | This paper is a first attempt to connect the heterogeneity in bank efficiency with lending fluctuations and allocation efficiency : there is a trade-off between the two in the presence of heterogeneity in bank monitoring efficiency. The mechanism at hand is twofold. (a) First the rent extracted by the most efficient bank distorts incentives of entrepreneurs to undertake efforts. (b) Second banks specialising on contracts that do not include monitoring feature less cyclical fluctuations of aggregate lending. This has clear implications: (i) the presence of banking heterogeneity decreases firms’ average productivity as it increases adverse selection by entrepreneurs as well as favours rent extractions by banks; (ii) an individual bank featuring a lower cyclicality signals a lower efficiency in its monitoring abilities; (iii) a heterogeneous banking system featuring a lower cyclicality of aggregate lending might not be desirable as it may come along with allocative and incentives distortions. |
| Keywords: | firms’ bankruptcy, economic crisis, survival, duration model. |
| JEL: | G21 E30 |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:bfr:banfra:464&r=cta |
| By: | James Albrecht (Georgetown University) |
| Abstract: | In this paper, we consider the efficiency of entry in a model of competitive search. By "competitive search" we mean that we analyze a large market in which buyers (or sellers) can direct their search based on the terms of trade that are posted (with commitment) by their counterparts on the other side of the market. We consider in particular entry on the side of the market on which the terms of trade are advertised. We generalize this literature on efficiency entry on competitive search in two directions. First, we allow for many-on-one meetings; e.g., a seller may interact with two or more buyers at the same time. Second, we allow for asymmetric information; e.g., a seller may not know how much the buyers she is interacting with value her good. |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed013:602&r=cta |
| By: | Kvaløy, Ola; Nieken, Petra; Schöttner, Anja |
| Abstract: | We conducted a field experiment in a controlled work environment to investigate the effect of motivational talk and its interaction with monetary incentives. We find that motivational talk significantly improves performance only when accompanied by performance pay. Moreover, performance pay slightly reduces performance unless it is accompanied by motivational talk. These effects also carry over to the quality of work. Performance pay alone leads to more mistakes. Adding motivational talk makes the difference. In treatments with performance pay, motivational talk increases output by about 20 percent and reduces the ratio of mistakes by more than 40 percent. |
| Keywords: | Verbal Motivation; Performance Pay; Field Experiment |
| JEL: | C93 M52 J33 |
| Date: | 2013–12 |
| URL: | http://d.repec.org/n?u=RePEc:trf:wpaper:451&r=cta |
| By: | Andreas Hildenbrand (University of Gießen); Mihael Duran (University of Tuebingen) |
| Abstract: | A monopolist is treated as a nexus of contracts with team production. It has one ownermanager. The owner-manager is the employer of two employees. A team production problem is present if the employer is a “managerial lemon”. If the team production problem is solved, the employer is a “managerial hotshot”. Both a managerial hotshot and a managerial lemon are found to make profit. Managerial slack can therefore exist in our monopoly market. In the case of a managerial lemon, the profit level is lower. However, the employees’ utility level is higher. Whereas the employer has an incentive to improve management capability in principle, the employees have an incentive to keep management capability low. Moreover, the cost of improving management capability may be prohibitively high. Managerial slack can therefore persist. The predicted behavior of the monopolist is grounded in individual behavior under the assumption of utility maximization. |
| Keywords: | firm organization, market structure, property rights |
| JEL: | C7 D2 D4 L1 L2 |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:mar:magkse:201353&r=cta |
| By: | Herweg, Fabian; Müller, Daniel |
| Abstract: | We extend Akerlof (1970)’s “Market for Lemons†by assuming that some buyers are overconfident. Buyers in our model receive a noisy signal about the quality of the good that is on display for sale. Overconfident buyers do not update according to Bayes’ rule but take the noisy signal at face value. We show that the presence of overconfident buyers can stabilize the market outcome by preventing total adverse selection. This stabilization, however, comes at a cost: rational buyers are crowded out of the market. |
| Keywords: | Adverse Selection; Market for Lemons; Overconfidence |
| JEL: | D82 L15 |
| Date: | 2013–12–17 |
| URL: | http://d.repec.org/n?u=RePEc:trf:wpaper:452&r=cta |
| By: | Theodore, Koutmeridis |
| Abstract: | During the past four decades both between and within group wage inequality increased significantly in the US. I provide a microfounded justification for this pattern, by introducing private employer learning in a model of signaling with credit constraints. In particular, I show that when financial constraints relax, talented individuals can acquire education and leave the uneducated pool, this decreases unskilled inexperienced wages and boosts wage inequality. This explanation is consistent with US data from 1970 to 1997, indicating that the rise of the skill and the experience premium coincides with a fall in unskilled-inexperienced wages, while at the same time skilled or experienced wages do not change much. The model accounts for: (i) the increase in the skill premium despite the growing supply of skills; (ii) the understudied aspect of rising inequality related to the increase in the experience premium; (iii) the sharp growth of the skill premium for inexperienced workers and its moderate expansion for the experienced ones; (iv) the puzzling coexistence of increasing experience premium within the group of unskilled workers and its stable pattern among the skilled ones. The results hold under various robustness checks and provide some interesting policy implications about the potential conflict between inequality of opportunity and substantial economic inequality, as well as the role of minimum wage policy in determining the equilibrium wage inequality. |
| Keywords: | wage inequality, experience premium, skill premium, employer learning, signaling, financial constraints, minimum wages, |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:edn:sirdps:467&r=cta |