Delegation to a possibly ignorant agent

In a delegation problem, an uninformed principal delegates decision‐making powers to a biased and possibly ignorant agent. The principal cannot use monetary payments but can restrict the set of the agent's choices. I show that in the general case, the principal may offer a disconnected set of choices. In a setting with arbitrary bias the uncertainty principle holds—the principal benefits as the likelihood that the agent is informed increases. When the bias is constant, I show that the ally principle holds—the principal benefits as the bias becomes smaller. Finally, when the likelihood of the agent being informed is determined by the agent's effort, then for small biases the principal benefits from limiting the agent's choice. When the agent is sufficiently biased, the principal gives more choice to the agent, so as to to improve incentives for information acquisition.     

Why it Pays to Conceal: On the Optimal Timing of Acquiring Verifiable Information

Abstract. We consider optimal contracts when a principal has two sources to detect bad projects. The first one is an information technology without agency costs (IT_P), whereas the second one is the expertise of an agent subject to moral hazard, adverse selection and limited liability (IT_A). First, we show that the principal does not necessarily benefit from access to additional information and thereby may prefer to ignore it. Second, we discuss different timings of information release, i.e., a disclosure contract offered to the agent after the principal announced the result of IT_P , and a concealment contract where the agent exerts effort before IT_P is checked. We find that concealment is superior whenever the quality of IT_P is sufficiently low. Then, IT_P is almost worthless under a disclosure contract, while it can still be exploited to reduce the agent's information rent under concealment. If the quality of IT_P improves, disclosure can be superior as it allows to adjust the agent's effort to the updated expected quality of the project. However, even for a highly informative IT_P , concealment can be superior as it mitigates the adverse selection problem.     

Strategic obscurity in the forecasting of disasters

A principal acquires information about a shock and then discloses it to an agent. After the disclosure, the principal and agent each decide whether to take costly preparatory actions that yield mutual benefits but only when the shock strikes. The principal maximizes his expected payoff by ex ante committing to the quality of his information, and the disclosure rule. We show that even when the acquisition of perfect information is costless, the principal may optimally acquire imperfect information when his own action eliminates the agent's incentive to take action against the risk.     

GRANTING AN EXIT OPTION TO CONDUCT AN AUDIT

We study a principal–agent relationship with auditing in which information from an audit is ‘soft’– by conducting an audit, the principal observes the agent's private information, but cannot obtain verifiable evidence on the information. Moreover, the principal's auditing effort is unverifiable in our model. Therefore, besides the agent's misreporting incentive, there is the principal's incentive to accuse the truthful agent even without auditing. If the principal's auditing effort is verifiable, granting no exit option to the agent is optimal although the principal can still accuse a truthful agent after the audit. We show that when the principal's auditing effort is unverifiable, granting an exit option to the agent and auditing are complementary. Without granting an exit option to the agent, no auditing is optimal, and the principal grants an exit option to conduct a sincere audit, which in turn mitigates the agent's misreporting incentive. Our analysis also reveals that, when the cost of auditing is sufficiently large, the principal conducts more sincere audits with a smaller amount of penalty.     

Discretionary rewards as a feedback mechanism

This paper studies the use of discretionary rewards in a finitely repeated principal–agent relationship with moral hazard. The key aspect is that rewards have informational content. When the principal obtains a private subjective signal about the agent's performance, she may pay discretionary bonuses to provide credible feedback to the agent. In accordance with the often observed compression of ratings, we show that in equilibrium the principal communicates the agent's interim performance imperfectly, i.e., she does not fully differentiate good and bad performance. Furthermore, we show that small rewards can have a large impact on the agent's effort, provided that the principal's stake in the project is small.     

Wealth effects and agency costs

We analyze how the agent's initial wealth affects the principal's expected profits in the standard principal–agent model with moral hazard.We show that if the principal prefers a poorer agent for all specifications of action sets, probability distributions, and disutility of effort, then the agent's utility of income must exhibit a coefficient of absolute prudence less than three times the coefficient of absolute risk aversion for all levels of income, thus strengthening the sufficiency result of Thiele and Wambach (1999). Also, we prove that there is no condition on the agent's utility of income alone that will make the principal prefer richer agents. Moreover, we show that, for an interesting class of problems, the principal prefers a relatively poorer agent if agent's wealth is sufficiently large. Finally, we discuss how alternative ways of modeling the agent's outside option affects the principal's preferences for agent's wealth.     

Relationship lending and innovation: empirical evidence on a sample of European firms

This paper investigates the impact of relationship lending on innovation (the probability to innovate and the intensity of innovation). Using a unique dataset providing detailed information on bank–firm relationships across European firms, we relate different proxies of relationship lending (soft information, long-lasting relationships, number of banks and share of the main bank) to innovation. We find a very strong and robust positive effect of ‘soft-information-intensive’ relationships, a less robust positive effect of long-lasting relationships and a negative effect of credit concentration as measured by the number of banking relationships. We also find that ‘soft-information-intensive’ relationships reduce credit rationing for innovative firms, while long-lasting relationships seem to favour innovation via other relational channels. These results raise some concern on the impact of screening processes based on automatic procedures, as those suggested by the Basel rules, on firms' capability to finance innovative activities in Europe.     

WHY DOES IT MATTER THAT BELIEFS AND VALUATIONS BE CORRECTLY REPRESENTED?*

This article contains an analysis of a simple principal–agent problem illustrating possible problems that may arise when the prinicpal ascribes to the agent subjective probabilities and utilities that are implied by the subjective expected utility model but do not represent the agent's beliefs and valuations. In particular, it is possible that an incentive contract designed by the principal induces the agent to choose an action that is not in the principal's best interest.     

Robustness of simple menus of contracts in cost-based procurement

We consider a model of cost-based procurement in which the principal faces Knightian uncertainty about the agent's preferences for cost reduction. We show that a particularly simple incentive scheme—a menu comprising a fixed-price contract and a cost-reimbursement contract—minimizes the maximum expected payment, where this maximum is taken over the set of possible agent preferences. For some parameters of the problem, a range of alternative incentive schemes also satisfy this criterion. We show that the simple incentive scheme is not weakly dominated by any of the alternatives: there does not exist an alternative mechanism for which the expected payment is no higher for all realizations of the agent's preferences and strictly lower for some realization.     

MARKET‐BASED INCENTIVES

In this article, we study market‐induced, external incentives similar to career concerns jointly with standard, contractual incentives linking compensation to performance. We consider a dynamic principal–agent problem in which the agent's outside option is determined endogenously in a competitive labor market. In equilibrium, strong performance increases the agent's market value. When this value becomes sufficiently high, the threat of the agent quitting forces the principal to increase the agent's compensation. The prospect of obtaining this raise gives the agent an incentive to exert effort, which reduces the need for standard incentives. In fact, whenever the agent's option to quit is sufficiently close to being “in the money,” the market‐induced incentive eliminates the need for standard incentives altogether: Compensation becomes completely insensitive to current performance.     

Asset Specificity,R&D Financing,And The Signalling Properties of The Firm's Financial Structure

Equity financing is the optimal strategy for innovating firms, which can use their financial structure as a signalling device to attract outside investors. This situation is likely to arise when the firm undertakes a specific purpose R&D project aimed at developing a certain product innovation. Typically, innovations of this kind draw on the firm's cumulative. idiosyncratic knowledge base and, accordingly, the innovation process involves an high degree of asset specificity. Under such circumstances, the terms of debt financing will be adjusted adversely, and equity financing will represent the most economically efficient solution.

These arguments are developed in standard static principal-agent models dealing with New Technology Based Firms and publicly held large firms undertaking an aggressive R&D strategy. In the case of NTBFs, two kinds of optimal venture capital contracts are considered, which render the sharing rules independent (a) of the agent's action and (b) of both the agent's action and the specific assets involved in the transaction. Regarding innovating large firms, it is argued that in this case, too, equity represents the optimal financing strategy, and that top executives use their equity share to signal the firm's expected return stream and value to outside investors.     

ENDOGENOUS PUNISHMENTS IN AGENCY WITH VERIFIABLE EX POST INFORMATION*

The article studies an adverse selection model in which a contractible, imperfect signal on the agent's type is revealed ex post. The agent is wealth constrained, which implies that the maximum penalty depends on the contracted transaction (e.g., the volume of trade). First, we show that the qualitative effects of the signal can be unambiguously tied to the nature of the problem (e.g., whether the agent is in a “buyer” or a “seller” position). Second, the distortions caused by informational asymmetries may become more severe although more information is now available. Finally, the signal can actually serve to increase the agent's informational rents.     

Principles versus principal: Reconciling norm compliance and shareholder value

This paper considers situations where an agent (say, a polluting firm's CEO) must allocate his nonobservable effort across two distinct tasks (say, revenue/market share enhancement and environmental stewardship), and where two principals (say, the firm's shareholders and an external stakeholder) hold diverging viewpoints on what the best allocation should be. Both characteristics of this context—multitasking and conflicting principals—are normally seen as obstacles to strengthening the agent's incentives. This paper proposes a simple arrangement, based on contingent monitoring and clawbacks, that can overcome these obstacles. Under this arrangement, the principals would end up coordinating their respective incentive schemes so that the agent considers his two tasks as complementary utility‐increasing activities. Applications to regulatory compliance, corporate social responsibility, and innovation management are briefly sketched.     

Communication in bargaining over decision rights

This paper develops a model of bargaining over decision rights between an uninformed principal and an informed but self-interested agent. We introduce two different bargaining mechanisms: tacit and explicit bargaining. In tacit bargaining, an uninformed principal makes a take-it-or-leave-it price offer to the agent, who then decides whether to accept or reject the offer. In the equilibrium of the game, the principal inefficiently screens out some agent types so that the agent's private information cannot be fully utilized when the decision is made. In explicit bargaining in which parties can communicate explicitly via cheap talk before tacit bargaining, however, an equilibrium with no such inefficient screening exists even when the conflict of interest is arbitrarily large. We also follow a mechanism design approach, showing that under certain conditions, explicit bargaining is an optimal bargaining mechanism that maximizes the joint surplus of the parties.     

Can Agents Be Better Off with Pay Caps?

A popular way to discipline the managers of companies or banks that got into trouble during the recent financial crisis has been to impose caps on managers' pay. Using a small extension of the standard principal–agent model, we argue that pay caps might serve the opposite purpose, because the agent might be better off with a pay cap. Specifically, we show that, given a fixed effort level to be implemented, the agent's expected utility can be decreasing in an upper bound for the agent's reward. The effect of pay caps on the general structure of optimal incentive contracts is also characterized. While an improvement of contracting information always helps the principal, it might increase or decrease the marginal cost of imposing pay caps.     

Innovation performance across Europe

The innovation performance of firms is primarily determined by their own innovative activities and the interaction with their innovation-related environment. This environment typically differs among countries. We assess empirically these differences on firms' innovation performance. To that end we first estimate the relationship between an aggregate innovation input measure and an aggregate innovation output measure, thereby explicitly controlling for structural differences between countries. We then consider the extent to which firms located in a particular country perform better or worse than this estimated benchmark performance. The analysis is based on a panel dataset that we have constructed from Eurostat's first and second Community Innovation Survey. In order to control for possible data contamination we employ an outlier-robust estimator. It appears that among the fourteen countries considered Italy, Germany and Ireland offer an environment that facilitates most the transformation of innovation-related inputs into commercial outputs while the environment in Denmark is the least facilitating.     

Private investment with social benefits under uncertainty: The dark side of public financing

We develop a game‐theoretic model of private–public contribution to a long‐term project with sequential actions and moral hazard. A private agent is one who is in charge of both the financial contribution and the management effort, these two actions entailing private costs and uncertain ex‐post private and social benefits. A public agent is one who decides the amount of public funding to this quasi‐public good, knowing that the size and the probability of attaining a surplus ex post depend on the private agent's effort. We consider four public‐funding scenarios: benefit‐sharing versus cost‐sharing crossed with ex‐ante versus ex‐interim government intervention. We test our theoretical predictions by means of an experiment that confirms the main result of the model: Cost‐sharing public intervention is more effective than benefit‐sharing in boosting private financial contribution to the project. Furthermore, when public intervention comes after private contribution ( ex‐interim government intervention), both public‐funding scenarios have a negative impact on the private management effort. In our model, the latter result is explained by the private agent's high degree of risk aversion. These results have policy implications for strategic investments with long‐term social consequences. In deciding the optimal timing and method of the contribution, governments should also consider the indirect effects on agents’ long‐term management efforts.     

Choosing the agent's group identity in a trust game with delegated decision making

Members of a given social group often favor members of their own group identity over people with different group identities. We construct a trust game in which the principal delegates the decision about an investment into a receiver to an agent who either favors the principal's or the receiver's group identity. When choosing the agent's group identity the principal faces a trade‐off between a loyal agent and an agent who might increase the receiver's willingness to cooperate. We solve for the principal's decision in a subgame‐perfect nash equilibrium for the two scenarios of a risk‐neutral and risk‐averse agent, respectively.     

Beneficial collusion in corruption control: The case of nonmonetary penalties

We analyze a corruption model where a principal seeks to control an agent's corruption by supplementing a costless noncollusive outside detector such as the media with a collusive internal supervisor. The principal's objective is to minimize the overall costs, made up of enforcement costs and social costs of corruption. If the penalties on the corrupt agent and a failing supervisor are nonmonetary in nature and yet the two parties can engage in monetary side-transfers, the principal may stand to benefit by allowing supervisor–agent collusion. This benefit may even prompt the principal to actively encourage collusion by hiring a dishonest supervisor in strict preference over an honest supervisor.