Optimal incentive contracts with multiple agents

A setting in which a single principal contracts with two agents who possess perfect private information about their own productivity is considered. With correlated productivities, each agent's private information also provides a signal about the other agent's productivity. In contrast to the setting in which there is only one agent, it is shown that such private information may be of no value to the agents. It is only if the agents are risk-averse that their private information may allow them to command rents. Moreover, when the agents are constrained only to reveal their private information truthfully as a Nash equilibrium, the Pareto optimal incentive scheme may induce the agents to adopt strategies other than truth-telling. This leads to the consideration of truth-telling equilibria that are not Pareto dominated in the subgame played by the agents. Among all such equilibria, the one preferred by the principal restricts one agent to tell the truth as a dominant strategy and the other as a Nash response to truth.     

Optimal debt contracts under costly enforcement

We consider a financing game where monitoring is costly, non-contractible and allowed to be stochastic. The optimal contract, which is debt, induces creditor leniency and strategic defaults on the equilibrium path, consistent with empirical evidence on repayment and monitoring behavior in credit markets. Our paper is the first where the optimal contract is debt and default is not synonymous with bankruptcy.     

Group incentive compatibility for matching with contracts

Hatfield and Milgrom [Hatfield, John William, Milgrom, Paul R., 2005. Matching with contracts. Amer. Econ. Rev. 95, 913–935] present a unified model of matching with contracts, which includes the standard two-sided matching and some package auction models as special cases. They show that the doctor-optimal stable mechanism is strategy-proof for doctors if hospitals' preferences satisfy substitutes and the law of aggregate demand. We show that the doctor-optimal stable mechanism is group strategy-proof for doctors under these same conditions. That is, no group of doctors can make each of its members strictly better off by jointly misreporting their preferences. We derive as a corollary of this result that no individually rational allocation is preferred by all the doctors to the doctor-optimal stable allocation.     

Group incentive compatibility for matching with contracts

Hatfield and Milgrom [Hatfield, John William, Milgrom, Paul R., 2005. Matching with contracts. Amer. Econ. Rev. 95, 913–935] present a unified model of matching with contracts, which includes the standard two-sided matching and some package auction models as special cases. They show that the doctor-optimal stable mechanism is strategy-proof for doctors if hospitals' preferences satisfy substitutes and the law of aggregate demand. We show that the doctor-optimal stable mechanism is group strategy-proof for doctors under these same conditions. That is, no group of doctors can make each of its members strictly better off by jointly misreporting their preferences. We derive as a corollary of this result that no individually rational allocation is preferred by all the doctors to the doctor-optimal stable allocation.     

Optimal multilateral contracts

Summary The purpose of this paper is to derive the structure of optimal multilateral contracts in a costly state verification model with multiple agents who may be risk averse and need not be identical. We consider two different verification technology specifications. When the verification technology is deterministic, we show that the optimal contract is a multilateral debt contract in the sense that the monitoring set is a lower interval. When the verification technology is stochastic, we show that transfers and monitoring probabilities are decreasing functions of wealth. The key economic problem in this environment is that optimal contracts areinterdependent. We are able to resolve this interdependency problem by using abstract measure theoretic tools.We wish to thank Mark Feldman, Wayne Shafer and Nicholas Yannelis for useful comments. We also gratefully acknowledge financial support from the National Science Foundation (SES 89-09242).     

Optimism bias and incentive contracts in portfolio delegation

This paper incorporates the well-documented managerial optimism bias into a standard portfolio delegation problem to study its impact on investment strategies and the optimal incentive contract offered by the investor to the manager. It is shown that the optimistic manager trades a larger quantity of the risky asset and thus takes more risk than the rational manager. Managerial optimism bias can offset her risk aversion and increase the investor's wealth by reducing moral hazard between the investor and the manager. Furthermore, a pronounced optimism bias reduces the incentive component of the incentive contract, suggesting that an optimistic manager requires fewer incentives to align her decisions with the interests of the investor.     

Informal incentive labour contracts and product market competition

This paper studies the dynamic interaction between product market competition and incentives against shirking. In contrast with standard results, efficiency wages paid by each firm can decrease when competition (i.e. the number of firms in the product market) increases. Discretionary bonuses, on the other hand, do not vary with competition. There is an upper threshold for the number of competing firms, however, above which such schemes are no longer sustainable as an equilibrium. Industry profits with bonuses are generally higher than with efficiency wages but, when information regarding firms’ misbehaviour flows at a low rate, a competition range exists for which firms can make a positive profit by only paying efficiency wages.     

Bargaining and inequity aversion: On the efficiency of the double auction

In a bargaining setting with asymmetrically informed, inequity-averse parties, a fully efficient mechanism (i.e., the double auction) exists if and only if compassion is strong. Less compassionate parties do not trade in the double auction in the limit of strong envy.     

Risk aversion and incentive compatibility with ex post information asymmetry

Summary. The paper extends Diamond's (1984) analysis of financial contracting with information asymmetry ex post and endogenous “bankruptcy penalties” to allow for risk aversion of the borrower. The optimality of debt contracts, which Diamond obtained for the case of risk neutrality, is shown to be nonrobust to the introduction of risk aversion. This contrasts with the costly state verification literature, in which debt contracts are optimal for risk averse as well as risk neutral borrowers. Received: December 7, 1998; revised version: June 9, 1999     

Optimal employment contracts with bankruptcy constraints

Consider the optimal incentive compatible contract offered by a firm with private information to its risk-averse employees. If the firm is subject to a binding limited liability or bankruptcy constraint then the contract will yield underemployment in low productivity states (relative to full-information efficiency). Such contracts either yield underemployment in all states, or excessively high variability in employment.     

Auctioning incentive contracts: The common cost,independent types case

Laffont and Tirole (1987) analyzed the problem of a regulator that wants to select one ofn firms to carry out a single indivisible project when the firms have private and independent costs and have the possibility of an ex-post investment in (non-observable) effort to reduce the (observable) cost.This paper generalizes the analysis to a model of common costs, unknown at the bidding stage, while keeping the assumption of independent types. I show that the main characteristics of the private costs model are kept in a common cost framework. I provide two mechanisms that may be used to implement the optimal contract.This is a much revised version of a part of chapter one of my Ph.D. dissertation. I would like to thank Drew Fudenberg, Oliver Hart, and two anonymous referees for their comments. I am especially indebted to Jean Tirole, who suggested this problem to me. I have also benefited from presentations at MIT and the EARIE 93 Meeting. Financial support from INVOTAN (grant 3/88/PO) is gratefully acknowledged. Remaining errors are my own.     

Optimal incentive schemes: Existence and characterization

A set of conditions under which the principal—agent problem admits solutions is given, and conditions characterizing such solutions are defined. As a consequence it is shown that ‘joint-risk-aversion’ leads to optimal contracts which are continuous.     

Banking,incentive constraints,and demand deposit contracts with nonlinear returns

Summary This paper presents two results regarding banking theory: (1) demand deposit contracts are essential in providing insurance against preferences shocks, as in Diamond and Dybvig (1983), if and only if the incentive compatibility conditions bind at the social optimum; and (2) for additively separable preferences with random discount factors, demand deposit contracts have the realistic feature that the interest rate paid is an increasing function of deposit balance.This paper is based on Chapter 2 of my Ph.D. dissertation submitted to the Graduate School of The University of Minnesota. I am indebted to Neil Wallace for his advice and guidance. I thank an anonymous refree for comments on a previous version of the paper. The comments from Edward Green, Nobuhiro Kiyotaki, Antonio Merlo, and Arijit Mukherji are appreciated.     

The incentive effect in share contracts: The case of finite resources

Using share contracts is a universal response to exchange under uncertainty. However, the benefits of share payments are tempered by their negative moral hazard incentive effects. By incorporating geological considerations into the producer's wealth-maximizing decision problem, this paper demonstrates these incentive effects in the case of nonrenewable resources. This paper also develops an expression for estimating the size of the incentive effects in the case of petroleum production. This expression shows that underproduction is a function of the royalty rate used and certain reservoir characteristics that can be easily estimated from publicly available data. Using such data, this paper demonstrates that such production loss can be a significant portion of cumulative production.