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.     

Disagreement and informal delegation in organizations

To investigate delegation decisions within organizations, we develop a principal-agent model in which the principal can only informally delegate authority to the agent and the parties openly disagree with each other in the sense of differing prior beliefs about the optimal course of action. Our analysis shows that the degree of disagreement determines what kind of delegation policy the principal can commit to and this, in turn, alters the agent’s effort for information acquisition. Notably, at moderate degrees of disagreement, conditional delegation may arise in equilibrium, whereby the principal credibly commits to allowing the agent to exercise his authority only if he generates additional information about the optimal action. Further, we discuss two extensions in which the principal undertakes an investment that reduces the agent’s cost of acquiring information, and the agent discloses his private information strategically.     

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.     

The Incentive Effects of Flat-Fee and Percentage Commissions for Real Estate Brokers

This paper analyzes the incentive affects of flat-fee and percentage commission systems from the perspective of the economic theory of agency. Under a plausible set of assumptions the systems provide equivalent incentives. However, the relative desirability of the two systems depends upon the pricing strategy employed and factors specific to the individual. In general, neither system perfectly aligns the interests of the agent with those of the property-owner. A surprising result of the analysis is that the optimal listing price when an agent is employed may be below the first-best price. The first-best price, or residual maximizing solution to the principal-agent problem from the perspective of the property-owner, is the solution that would occur if the agent's interests were perfectly aligned with those of the principal. This study suggests that the use of a percentage versus a flat-fee commission may be due to information costs rather than price discrimination on the part of brokers.     

On Multitasking and Job Design in Relational Contracts*

We investigate job design problems in relational contracting environments with multitasking and an aggregated and distorted performance measurement. Compared to assigning all the tasks to a single agent, assigning the tasks to multiple agents mitigates misallocation of effort among the tasks but tightens the self-enforcing constraint. Consequently, task separation is optimal if and only if the discount factor is high. Some tasks may not be assigned to the agents at all under the optimal job design. When the principal provides explicit incentives as well, it may be the case that task bundling is suboptimal for any discount factor.     

Optimal organization in a sequential investment problem with the principal's cancellation option

This paper considers a two-stage sequential investment problem where the principal wishes to cancel the project if it fails in the first stage. Suppose that only the first-stage agent can observe the outcome in the first stage. There are two organizational forms to choose from: integration, where a single agent is in charge of investments in two stages; and separation, where two different agents are in charge of the two stages. Integration gives rise to a smaller wage cost of inducing high effort in both stages; however, in order to obtain the correct information to cancel the project, separation may have some advantage in terms of saving the information rent. We show that when the effort cost in the first stage is sufficiently small, the principal prefers separation because the first-stage agent has less incentive to lie about the outcome.     

Aggregate Information and Organizational Structures*

We study information flows in an organization with a top management (principal) and multiple subunits (agents) with private information that determines the organization's overall efficiency. Under centralized communication, eliciting the agents' information may induce the principal to manipulate aggregate information, which obstructs an effective use of information. Under hierarchical communication, the principal concedes more information rent due to loss of control, but is able to use the agents' information more effectively. The trade-off between the organizational structures depends on the likelihood that the agents are efficient. Centralized communication is optimal when such likelihood is low. Hierarchical communication, by contrast, is optimal when it is high.     

Accept or reject? An organizational perspective

This paper compares the relative performance of different organizational structures for the decision of accepting or rejecting a project of uncertain quality. When the principal is uninformed and relies on the advice of an informed and biased agent, cheap-talk communication is persuasive and it is equivalent to delegation of authority, provided that the agent's bias is small. When the principal has access to additional private information, cheap-talk communication dominates both (conditional) delegation and more democratic organizational arrangements such as voting with unanimous consensus.     

Motivating with simple contracts

In practice, incentive schemes are rarely tailored to the specific characteristics of contracting parties. However, according to economic theory, optimal contracts should be highly dependent on individual conditions. We reconcile these observations in the context of a principal-agent model with both moral hazard and adverse selection. Motivating an agent could be increasingly costly to the principal because a more productive agent could also be more able to manipulate the terms of the contract. As a result, the principal may optimally pool some types by offering a contract with constant transfer and bonus. We also explore parameterizations where the optimal contract is fully separating but simple contracts attain a significant portion of the optimal welfare.     

Ex ante or ex post competition policy? A progress report

When intervening in markets, say to block a merger, competition authorities are constrained by the limited information they have about the social desirability of the available alternatives. Compared to ex ante control, ex post control is based on the more accurate information that becomes available in the intervening period, but entails temporary losses to social welfare and reversal costs incurred to unscramble the eggs. Through a toy model, we identify situations in which the competition authority finds it optimal to commit to forego the option of ex post review in order to avoid chilling ex ante socially beneficial mergers. On the other hand, the case for ex post review is strengthened if post-merger market conducts can signal the merged firm's private information about the consequences of the merger.     

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.     

Economic integration and new firm formation: Britain's impact on Irish enterprise

The paper examines the impact of economic integration on enterprise in a small open economy. The paper analyses large, small and total new company registrations in Ireland. It examines the impact of spill-overs from the United Kingdom labour and product markets on Irish firm formation. The study finds that negative labour market spill-overs dominate positive product market spill-overs so that a net negative effect results from Irish-British economic integration. The results indicate that enterprise in peripheral economies may be more vibrant if product market integration is introduced before labour market integration. The paper also finds enterprise to be positively affected by the number of university graduates in the labour force. House prices are found to have a net negative impact on enterprise.     

Securities auctions with pre-project information management

This paper analyzes securities auctions in which bidders have an option to acquire information after winning the right to develop a project. The payment consists of an up-front cash bid and a contingent security bid, which distorts investment and information acquisition relative to the first-best. We order securities in terms of their steepness: the payment of a steeper security is more sensitive to high project values. The agent’s incentives to acquire information that prevents either cost overruns (Type I errors) or false cancellations (Type II errors) decrease with the steepness of securities. The optimal limited-liability securities auction involves bidding debt that minimizes the distortions in the agent’s incentives to acquire performance-enhancing information. The model delivers implications on the practices commonly observed in oil lease auctions.     

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).     

Agricultural research spending must increase in light of future uncertainties

Agricultural productivity depends critically on investments in research and development (R&D), but there is a long lag in this response. Failing to invest today in improvements of agricultural productivity cannot be simply corrected a few decades later if the world finds itself short of food at that point in time. This fundamental irreversibility is particularly problematic in light of uncertain future population, income, and climate change, as portrayed in the IPCC’s Shared Socio-Economic Pathways (SSPs). This paper finds the optimal path of agricultural R&D spending over the 21st century for each SSP, along with valuation of those regrets associated with investment decisions later revealed to be in error. The maximum regret is minimized to find a robust optimal R&D pathway that factors in key uncertainties and the lag in productivity response to R&D. Results indicate that the whole of uncertainty’s impact on R&D is greater than the sum of its individual parts. Uncertainty in future population has the dominant impact on the optimal R&D expenditure path. The robust solution suggests that the optimal R&D spending strategy is very close to the one that will increase agricultural productivity fast enough to feed the World under the most populous scenario. It also suggests that society should accelerate R&D spending up to mid-century, thereafter moderating this growth rate.     

The effects of a free-repair warranty on the discrete-time periodic replacement policy

This paper presents the effects of a free-repair warranty on a periodic replacement policy with a discrete time process. Considering a repairable product that should be operational at the time over an indefinitely long operation cycle n (n=1, 2, …), under the discrete-time periodic replacement policy, a product is preventively replaced at pre-specified operation cycles N, 2N, 3N, … (N=1, 2, …). When the product fails, a minimal repair is performed at the time of failure, and the failure rate is not disturbed by each repair. The cost models from the customers' perspectives are developed for both warranted and non-warranted products. The corresponding optimal replacement period N? is derived such that the long-run expected cost rate is minimized. Under the assumption of the discrete time increasing failure rate, the existence and uniqueness of the optimal replacement period are shown, and the impact of a free-repair warranty on the optimal periodic replacement policies is investigated analytically. The optimal N* for a warranted product should be adjusted toward the end of the warranty period. Finally, numerical examples are demonstrated for the optimal policy illustration and verification. The observations from the numerical results provide valuable information for a buyer (user) to adjust the optimal periodic replacement policy if a product is operating in discrete time under a free-repair warranty.     

How Much Do Employers Learn from Referrals?

This paper tests the hypothesis that referrals from various sources provide employers with more information about job applicants than they would have with‐out a referral. The study uses data that contain information on two workers in the same job, allowing the differences in job and firm characteristics to be canceled out and controlling for the possibility that workers with referrals from different sources (or no referral at all) sort into jobs that put different weights on individual performance. The estimation results are consistent with referrals from current employees providing employers with more information than they would have otherwise. Additionally, it appears as though hiring through friends or relatives of the employer may involve some favoritism that results in employers either collecting less information than they would otherwise or ignoring information when setting wages. The study finds weak evidence consistent with referrals from other firms or labor unions providing useful information, and no evidence that referrals from community organizations or other sources have any effect.     

Optimal Exit Policy with Uncertain Demand*

In a framework where entrants must make sunk investment decisions with uncertain returns and have private demand information, we show that the relationship between innovation and exit value is non-monotone and features an inverted U-shaped pattern. Consumer surplus is maximised at the lowest exit value that incentivises the investment. These insights are applied to optimal merger policy. An entrant is more willing to innovate to be acquired afterwards, even if it has no bargaining power. This innovation-for-buyout effect implies that an entrant is less likely to leave the market under a lenient than a strict merger policy.     

A practical approach to sensitivity analysis in linear programming under degeneracy for management decision making

Linear programming (LP) is a widely used tool in management decision making. Theoretically, sensitivity analysis of LP problems provides useful information for the decision maker. In practice, however, most LP software provides misleading sensitivity information if the optimal solution is degenerate. The paper shows how sensitivity analysis of LP problems can be done correctly when the optimal solution is degenerate. A production planning example is presented to illustrate the incorrect sensitivity analysis results automatically provided by most LP solvers. The general characteristics of the misleading results and the possible effects of this incorrect information on management decisions are also discussed.     

Piecewise procurement of a large-scale project

This paper studies the optimal piecewise procurement of a large-scale project. In the unique Markov Perfect Equilibrium (MPE) of the dynamic procurement game, it is found that (1) unlike the static setting, the procurer's optimal strategy depends on the number of suppliers and more importantly, it is nonmonotonic. As one more supplier participates in the procurement auction, the procurer softens competition in the initial stages by including more cost “types” while increasing competition in the mature stages; (2) this, in turn, implies that existing suppliers might favor participation of additional suppliers; (3) absent scheduling and/or resource constraints, the procurer prefers to procure the project as one piece if the suppliers' technology exhibits constant or increasing returns, and no additional suppliers are enticed to bid; and (4) the optimal dynamic mechanism can be easily implemented via a sequence of dominant strategy auctions of the Vickrey type.