Contracting with endogenous entry

We analyze entry in markets where a principal contracts with a privately informed agent. Before learning his production cost, the agent knows his probability of having a low cost – his ex ante “type” – and decides whether to pay an entry fee to contract with the principal. There are two cut-off equilibria that determine the possible types of an agent who actually enters the market, and neither equilibrium can be discarded by standard selection criteria. Contrasting with standard intuition, in the equilibrium with the highest cut-off an increase in the entry fee reduces the marginal type of the agent who enters, thus increasing entry and the expected cost of an entrant. This equilibrium is selected by a criterion based on “robustness to equilibrium risk,” even though the equilibrium with the lowest cut-off is Pareto dominant for the agent. Public policies that increase entry barriers may be welfare improving.     

Innovation in Labor Contracts: On the Adoption of Profit Sharing inCanadian Labor Contracts

I present a model in which I show that labor contracts with wages indexed to prices have longer optimal contract lengths and therefore are more likely to adopt performance-related pay. There is empirical support for these predictions in Canadian collective-bargaining agreements. Contract durations are longer in indexed contracts. Performance-related pay is more than twice as likely to be adopted and present in indexed contracts and more likely to be adopted in contracts with longer durations.     

Prepayment Penalty as a Screening Mechanism for Default and Prepayment Risks

The objective of this article is to offer a theoretical model of asymmetric information to analyze the screening role of prepayment penalty. We consider both default risk and prepayment risk. What makes the role of prepayment penalty interesting and more complicated is that a borrower's contract choice could send conflicting signals to the lender about that borrower's default and prepayment risk type. This is different from earlier theoretical models of mortgage choice under asymmetric information where a certain aspect of the contract (e.g., discount points or loan‐to‐value ratio) is explored as a screening mechanism for a single risk dimension (default risk or prepayment risk) of the borrower type. We show the existence of separating equilibria where different default and prepayment risk types choose contracts with different combinations of prepayment penalty and interest rate. For certain parameter combinations, the model also generates a pooling equilibrium where all borrower types obtain the same contract. Our analysis could offer a partial explanation for the observation that contracts with prepayment penalties are a lot less prevalent than contracts with points.     

Transparency in agency: The constant elasticity case and extensions

This paper considers a hidden action agency problem where the principal has a single source of hidden information concerning the agent's utility, the agent's effort productivity, or the agent's cost of effort. We examine whether the principal should precommit to disclosing these different single sources of information to the agent. If the optimal contract is invariant over the hidden information and, thus, the disclosure rules (constant elasticity case), such disclosure increases the agent's utility, it can raise or lower profit and total surplus depending on the source of hidden information, and non-disclosure can be optimal if disclosure affects the agent's motivation. If the contract varies with the hidden information and, thus, disclosure rule, disclosure or non-disclosure can be optimal depending on whether the party's payoff is convex or concave in the information variable, respectively.     

Information acquisition and optimal project management

This paper provides a rationale for why an organization often generates a bias in favor of a new project even after learning that its profitability will be certainly below more conventional ones. We analyze a principal–agent model with two alternative projects, one of which is to be chosen by the principal. In our model, the profitability of a project is determined by the cost of implementation. All parties are familiar with one of the projects (the known project), and thus the implementation cost of this project is common knowledge. Information on the other project (the new project), however, must be acquired by the agent. We find that the new project may be chosen in the optimal contract even when it turns out to be more costly to implement than the known project, if acquiring information is costly enough and the realized implementation cost of the new project is below a particular level. We also discuss distortion in the new project's output schedule when it is selected.     

Partial monitoring,adverse selection,and the internal efficiency of the firm

The paper investigates an adverse selection model with monitoring of managerial effort. In contrast to the literature, we assume that the manager can be punished only if his effort is below a certain level that is monitored by the principal. Surprisingly, the optimal labor contract may induce an equilibrium effort which is lower than in the standard model without monitoring. This result holds for any discrete distribution of managerial types. In the continuous type case, the optimal contracts for high-quality (low-quality) managers are purely output-dependent (effort-dependent).     

Farmers’ preferences for supermarket contracts in Kenya

With the modernization of global agri-food systems, the role of contract farming increases. This also involves smallholder farmers in developing countries. While previous studies have looked at economic impacts of contract schemes on smallholder farmers, little is known about farmers’ preferences for contracting in general, and for specific contract design attributes in particular. Better understanding farmers’ preferences and constraints is important to make smallholder contract schemes more viable and beneficial. This article builds on a choice experiment to analyze farmers’ preferences and preference heterogeneity for contracts in Kenya. In the study region, supermarkets use contracts to source fresh vegetables directly from preferred suppliers. However, farmer dropout rates are high. Mixed logit models are estimated to examine farmers’ attitudes towards critical contract design attributes. Having to deliver their harvest to urban supermarkets is costly; hence farmers require a significant output price premium. Farmers also dislike delayed payments that are commonplace in contract schemes. The most problematic contract attribute is related to unpredictable product rejection rates, substantially adding to farmers’ risk. Designing contracts with lower transaction costs, more transparent quality grading, and fairer risk-sharing arrangements could enhance smallholder participation in supermarket procurement channels.     

Financial and operational decisions in the electricity sector: Contract portfolio optimization with the conditional value-at-risk criterion

The restructuring of electricity markets around the world have caused increased volatility and uncertainty of the price power. As a result, providers of power now face increased uncertainty and risk in the operational and financial decisions related to procurement. Providers must seek optimal ways to deliver the required volume of power to retailers and end users while managing risk. We consider a mixed-integer programming model for a power providing agent that jointly considers the problem of selecting custom electricity contracts and finding the optimal procurement strategy of meeting contract obligations under spot price uncertainty. A two-stage stochastic integer programming (SIP) model with a conditional value-at-risk (CVaR) constraint to incorporate risk aversion is developed. Computational results are presented that demonstrates the CVaR approach and the results are compared with a corresponding expected cost minimization approach. The SIP model with CVaR will allow acceptance of contracts at lower prices compared to an approach based on a corresponding risk-neutral model as a hedge against uncertainty and mis-specified arbitrage.     

Moral hazard in strategic decision making

This paper develops a theory of moral hazard in which the agent takes the role of strategic decision-maker. Career concerns give rise to preferences over risk, which in turn create an incentive for the agent to manipulate the project’s risk-return tradeoff to the disadvantage of the principal. The resultant moral hazard can be ameliorated by an incentive contract. The optimal non-decreasing wage involves granting ‘in-the-money’ options. In the context of academic tenure, the optimal tenure standard requires the agent to exceed expectations, and lies within one standard deviation of the expected outcome.     

The Impacts of Contract Type on Broker Performance

This paper offers a theoretical and empirical analysis of the exclusive agency and exclusive-right-to-sell contracts used in real estate brokerage. The theoretical model predicts that while both contract types will yield the same price, the exclusive agency contract will result in faster sales than the exclusive-right-to-sell contract. In the empirical model, we find that houses sold faster under the exclusive agency contract than the exclusive-right-to-sell contract. However, houses sold with exclusive agency contracts also sold at a marginally lower price. We also find a slightly greater concession from the listing price at the negotiation stage of exclusive agency listings.     

The role of short-term contracts and subsidies in licensing

An innovator without production facilities owns a patented invention that lasts two periods, and looks for the best licensing arrangement with a producer that has private information about the market value of the invention. The license is either a single long-term contract in force over both periods or a series of short-term contracts, one per period. Under short-term contracts, the licensee can strategically signal the value of the invention with its level of production in the first period and thus influence the terms of the contract in the second period. We show that the licensor prefers successive short-term contracts rather than a single long-term contract for intermediate-level probabilities of dealing with an efficient licensee, while the first-period contract may optimally include a per-unit subsidy (a negative royalty rate) in order to correct signaling distortions in the licensee’s production for this period. We also show that prohibiting such subsidies can lead to welfare losses.     

Delegation of information verification

An agent may manipulate information when transmitting it to the principal. A direct response to this problem is to verify the information. The paper explores a situation where the principal engages in information verification herself or alternatively delegates it to the agent. The paper finds that delegated verification can be optimal if the agent has to expend costly effort to acquire information before verifying it. Delegated verification promotes the agent's incentive for information acquisition. The paper also finds that delegated verification is more likely to be optimal if the agent is more biased.     

Contract Design for Problem Asset Disposition

As a result of declining real estate values and the receivership of numerous financial institutions, government regulators like the Resolution Trust Corporation (RTC) and Federal Deposit Insurance Corporation (FDIC) have large inventories of distressed assets. This paper develops a model of the principal/agent issues associated with management and disposition of problem assets. In the model, optimal contracts balance risk sharing with incentives for effort. We argue that the RTC will minimize the ultimate cost of the thrift crisis by placing managerial control of distressed assets in the private sector, while retaining full or partial ownership of the assets for risk-sharing purposes. Recoveries are maximized, however, only when an asset manager is incented to expend a first-best level of effort by indexing asset management and disposition contracts to market movements.     

The value of transparency in multidivisional firms

We study internal incentives, transparency and firm performance in multidivisional organizations. Two independent divisions of the same firm design internal incentives, and decide whether to publicly disclose their performances. In each division a risk-neutral principal deals with a risk-averse (exclusive) agent under moral hazard. Each agent exerts an unverifiable effort that creates a spillover on the effort cost of the other agent. We first study the determinants of the optimal principal-agent contract with and without performance transparency. Then, we show how effort spillovers affect the equilibrium communication behavior of each division. Both principals commit to disclose the performance of their agents in equilibrium when efforts are complements, while no communication is the only equilibrium outcome when efforts are substitutes.     

Contract,cooperation, and performance in international joint ventures

This study examines how contract, cooperation, and performance are associated with one another within international joint ventures (IJVs). We argue that contract and cooperation are not substitutes but complements in relation to IJV performance. An IJV contract provides an institutional framework guiding the course of cooperation, while cooperation overcomes the adaptive limits of contracts. Our analysis of 293 IJVs in a dynamic market demonstrates that previous cooperation bolsters contractual adaptability, which in turn nurtures current cooperation between the same partners. We find that contract completeness and cooperation drive IJV performance both independently and interactively. When contracts are more complete, cooperation contributes more to performance. Contract and cooperation differ in their quadratic effects such that the contribution of contract completeness to performance declines as completeness increases but the contribution of cooperation remains linear. Copyright © 2002 John Wiley & Sons, Ltd.     

Centralized and Decentralized Contracts in a Moral Hazard Environment

We study the optimal allocation of the contracting capacity in a moral hazard environment. Centralizing is superior when the principal is able to establish all the contracts with the agents simultaneously and she is able to monitor side contracting between the agents. Otherwise, decentralizing can be a superior strategy. We apply our results to a firm's decision on which outlets to franchise. They suggest that franchising is more likely to occur the further the store is from headquarters, the more isolated it is and in those activities where the risk is low. This conclusion is consistent with empirical studies.     

Exclusivity Contracts,Insurance and Financial Market Foreclosure

We study the trade‐off between the positive effects (risk‐sharing) and negative effects (exclusion) of exclusivity contracts. We revisit the seminal model of Aghion and Bolton [ 1987 ] under risk‐aversion and show that although exclusivity contracts induce optimal risk‐sharing, they can be used not only to deter the entry of a more efficient rival into the product market but also to crowd out financial investors willing to insure the buyer at competitive rates. We further show that in a world without financial investors, purely financial bilateral instruments, such as forward contracts, achieve optimal risk‐sharing without distorting product market outcomes. Thus, risk‐sharing alone cannot be invoked to defend exclusivity contracts.     

Contract costing in outsourcing enterprises: Exploring the benefits of discrete-event simulation

Outsourcing is a business strategy that has received much attention. An increase in outsourcing has a direct influence on the complexity of supply chain networks and on the number of contracts required to manage a supply chain. Outsourcing contracts may be entered into relatively quickly without a full understanding of the true cost implications. The research described here aims to develop tools based on discrete-event simulation to aid outsourcing companies when costing contracts. Currently available software for this type of application is reviewed. A field study is presented from the electronics sector, describing companies’ needs with respect to contract costing and how simulation could be used in the contract costing process. Simulation approaches are described for different contract costing scenarios. The paper concludes with a case study of a preliminary simulation model that has been developed to test the concept with a specific outsourcing scenario.     

供应中断下双源采购的供应链契约设计

考虑由一个制造商和两个供应商构成的两级供应链契约设计问题,将可靠性服从随机分布的供应商作为主供应商,将完全中断供应商作为次供应商,建立以利润最大化为目标的签约和执行两阶段博弈的动态规划模型,得到制造商的最优契约设计。制造商根据产品零售价格的变化灵活做出只与一个供应商签约、与两个供应商同时签约或都不签约的决定,供应商根据契约设计内容决定自己的最优生产规模。研究表明：供应商最优生产规模与产品的单位生产成本呈负相关,与单位变动支付和单位惩罚成本呈正相关;次供应商的订货量与其本身的可靠性呈正相关,与主供应商的可靠性呈负相关;供应商的固定支付与其相应的可靠性呈负相关。     

Non-Exclusive Dealing with Retailer Differentiation and Market Penetration

Retailer differentiation exists in most industries and gives manufacturers an incentive to contract with different retailers to penetrate a market. This paper analyzes the impact of this penetration effect on vertical contract exclusivity in an oligopolistic model with differentiated retailers. In the model, manufacturers endogenously choose contract types and negotiate with retailers on wholesale prices. We show that, when the penetration effect is sufficiently strong, non-exclusive contracts lead to higher profits for the manufacturers and retailers. The model is applied to an example with logit demand, which shows that both manufacturers choosing the non-exclusive contracts is a dominant-strategy Nash equilibrium even though they may both be better off under exclusive contracts when the products have high quality or low costs.