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on Contract Theory and Applications |
| By: | Matthias Kiefer; Edward Jones; Andrew Adams (Heriot-Watt University) |
| Abstract: | Companies can be regarded as nexuses with contractual relationships between management and shareholders (Jensen and Meckling, 1976). The extent to which managerial and shareholder rewards are determined by incompleteness of contracts has been extensively studied (Hart, 1995a). Incomplete contracts affect the stability of the relationship between managers and shareholders as managers can leave or be dismissed (Oyer, 2004; Gillan, Hartzell, and Parrino, 2009). Furthermore, discretion for renegotiation of such contracts can be desirable, if stability is improved (Schwab and Thomas, 2006; Roberts and Sufi, 2009). Discretion for renegotiation of contracts between management and shareholders is increased in public companies when shareholders surrender control over management to boards (Blair and Stout, 1999; Peters and Wagner, 2014). Corporate stability, renegotiation of agreements and control rights over assets are not systematically captured by principal-agent models. |
| Keywords: | Board Insulation, Executive Compensation, Incomplete Contracts, Managerial Labor Market, Market for Corporate Control, Principal-Agent Model. |
| JEL: | D86 G38 J33 J65 K12 M52 |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:hwe:cfidps:1603&r=cta |
| By: | Bruno Biais (Université de Toulouse 1 Capitole) |
| Abstract: | We study the interaction between contracting and equilibrium pricing when risk- averse hedgers purchase insurance from risk-neutral investors subject to moral hazard. Moral hazard limits risk-sharing. In the individually optimal contract, margins are called (after bad news) to improve risk-sharing. But margin calls depress the price of investors' assets, affecting other investors negatively. Because of this re-sale ex- ternality, there is too much use of margins in the market equilibrium compared to the utilitarian optimum. Moreover, equilibrium multiplicity can arise: In a pessimistic equilibrium, hedgers who fear low prices request high margins to obtain more insurance. Large margin calls trigger large price drops, confirming initial pessimistic expectations. Finally, moral hazard generates endogenous market incompleteness, raises risk premia, and induces contagion between asset classes. |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed016:270&r=cta |
| By: | Santiago Moreno-BROMBERG (University of Zurich - Department of Banking and Finance); Guillaume ROGER (University of Sydney - School of Economics) |
| Abstract: | We study a dynamic contracting problem in which size is relevant. The agent may take on excessive risk to enhance short-term gains, which exposes the principal to large, infrequent losses. To preserve incentive compatibility, the optimal contract uses size as an instrument; there is downsizing on the equilibrium path. The contract may be implemented using the full array of financial securities or as a regulation contract with a leverage ratio. We show that holding equity is essential to curb risk taking. Firms that are less prone to risk taking can afford a higher leverage. |
| Keywords: | asymmetric information; dynamic contracts; moral hazard; risk taking |
| URL: | http://d.repec.org/n?u=RePEc:chf:rpseri:rp1564&r=cta |
| By: | Yuichiro Kamada (Haas School of Business, University of California Berkeley); Aniko Ory (Cowles Foundation, Yale University) |
| Abstract: | We incorporate word of mouth (WoM) in a classic Maskin-Riley contracting problem, allowing for referral rewards to senders of WoM. Current customers’ incentives to engage in WoM can affect the contracting problem of a firm in the presence of positive externalities of users. We fully characterize the optimal contract scheme and provide other comparative statics. In particular, we show that offering a free contract is optimal only if the fraction of premium users in the population is small. The reason is that by offering a free product, the firm can incentivize senders to talk by increasing expected externalities that they receive and this can (partly) substitute for paying referral rewards only if there are few premium customers. This result is consistent with the observation that companies that successfully offer freemium contracts oftentimes have a high percentage of free users. |
| Keywords: | Word-of-mouth, referral rewards, freemium, contract theory |
| JEL: | D82 L21 M3 |
| Date: | 2016–07 |
| URL: | http://d.repec.org/n?u=RePEc:cwl:cwldpp:2048&r=cta |
| By: | Benito Arruñada; Marco Casari |
| Abstract: | Contract enforcement does not only affect single transactions but the market as a whole. We compare alternative institutions that allocate enforcement rights to the different parties to a credit transaction: either lenders, borrowers, or judges. Despite all parties having incentives to enforce and transact, the market flourishes or disappears depending on the treatment: paying judges according to lenders' votes maximizes total surplus and equity; and a similar result appears when judges are paid according to average earnings in society. In contrast, paying judges according to borrowers' votes generates the poorest and most unequal society. These results suggest that parties playing the role of borrowers understand poorly the systemic consequences of their decisions, triggering under-enforcement, and hence wasting profitable trade opportunities. |
| Keywords: | impersonal exchange, third-party enforcement, steps of reasoning, other-regarding preferences, judicial independence. |
| JEL: | C91 C92 D53 D63 D72 K40 |
| Date: | 2016–07 |
| URL: | http://d.repec.org/n?u=RePEc:bge:wpaper:913&r=cta |
| By: | Miguel Antón (IESE Business School, Universidad de Navarra); Florian Ederer (Cowles Foundation, Yale University); Mireia Giné (IESE Business School, Universidad de Navarra); Martin Schmalz (University of Michigan) |
| Abstract: | Standard corporate finance theories assume the absence of strategic product market interactions or that shareholders don’t diversify across industry rivals; the optimal incentive contract features pay-for-performance relative to industry peers. Empirical evidence, by contrast, indicates managers are rewarded for rivals’ performance as well as for their own. We propose common ownership of natural competitors by the same investors as an explanation. We show theoretically and empirically that executives are paid less for own performance and more for rivals’ performance when the industry is more commonly owned. The growth of common ownership also helps explain the increase in CEO pay over the past decades. |
| Keywords: | Common ownership, competition, CEO pay, management incentives, governance |
| JEL: | D21 G30 G32 J31 J41 |
| Date: | 2016–07 |
| URL: | http://d.repec.org/n?u=RePEc:cwl:cwldpp:2046&r=cta |
| By: | Ronald Wolthoff (University of Toronto); Benjamin Lester (Federal Reserve Bank of Philadelphia) |
| Abstract: | This paper studies the effect of screening costs on the equilibrium allocation of workers with different productivities to firms with different technologies. In the model, a worker's type is private information, but can be learned by the firm during a costly screening or interviewing process. We characterize the planner's problem in this environment and determine its solution. A firm may receive applications from workers with different productivities, but should in general not interview them all. Once a sufficiently good applicant has been found, the firm should instead make a hiring decision immediately. We show that the planner's solution can be decentralized if workers direct their search to contracts posted by firms. These contracts must include the wage that the firm promises to pay to a worker of a particular type, as well as a hiring policy which indicates which types of workers will be hired immediately, and which types will lead the firm to keep interviewing additional applicants. |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed016:221&r=cta |