Demand deposit contracts,suspension of convertibility,and optimal financial intermediation

Summary This paper establishes that an optical contract, combining features of the well-known Diamond and Dybvig (1983) and Townsend (1979, 1983) models, resembles banking. The contract and the associated allocations are derived from a social planner's problem which contains the Diamond and Dybvig and Townsend models as sub-problems. The analysis accomplishes the following. It unites the liquidity preference and cost minimization literatures in a simple way; resolves the demand deposit/demand equity problem in the Diamond and Dybvig model; introduces a notion of efficient bankruptcies into the liquidity preference literature; and raises some questions about the government regulation vs. laissez faire banking debate.I wish to thank John Boyd, Joseph Haubrich, Jeffrey Lacker, Ramon Marimon, Edward C. Prescott, two anonymous referees, and especially Neil Wallace for useful comments. I also wish to thank the National Science Foundation for financial support from grant number 89-09242.     

Imperfect competition in two-sided matching markets

This paper considers a simple equilibrium model of an imperfectly competitive two-sided matching market. Firms and workers may have heterogeneous preferences over matches on the other side, and the model allows for both uniform and personalized wages or contracts. To make the model tractable, I use the Azevedo and Leshno (2013) framework, in which a finite number of firms is matched to a continuum of workers.In equilibrium, even if wages are exogenous and fixed, firms have incentives to strategically reduce their capacity, to increase the quality of their worker pool. The intensity of incentives to reduce capacity is given by a simple formula, analogous to the classic Cournot model, but depends on different moments of the distribution of preferences. I compare markets with uniform and personalized wages. For fixed quantities, markets with personalized wages always yield higher efficiency than markets with uniform wages, but may be less efficient if firms reduce capacity to avoid bidding too much for star workers.     

Citizen-candidates,lobbies, and strategic campaigning

We study a spatial model of political competition in which potential candidates need a fixed amount of money from lobbies to enter an election. We show that the set of pure strategy Nash equilibria in which lobbies finance candidates whose policies they prefer among the set of entrants coincides with the set of Nash equilibria with weakly less than two entering candidates. Fixing lobbies’ preferences, if the total amount of money held by lobbies is finite, there exists some minimal distance between the two candidates’ positions. This minimal distance is a bound for all such Nash equilibria and is independent of the distribution of voters’ preferences. I would like to thank John Duggan, Al Slivinski, and William Thomson for useful comments and suggestions. Dan Kovenock and two anonymous referees also provided detailed comments and pointed out several errors. All errors are my own.     

Bargaining under incomplete information, fairness, and the hold-up problem

In the hold-up problem incomplete contracts cause the proceeds of relationship-specific investments to be allocated by bargaining. This paper investigates the corresponding investment incentives if individuals have heterogeneous fairness preferences. Individual preferences are taken to be private information. Investments can then signal preferences and thereby influence beliefs and bargaining behavior. In consequence, individuals might choose high investments in order not to signal information that is unfavorable in the ensuing bargaining.     

Constant scoring rules,condorcet criteria and single-peaked preferences

Summary A constant scoring rule asks each individual to vote for a given (and constant) number of alternatives and the alternative with the most votes is elected. A sequential constant scoring rule applies this principle in a process of sequential elimination. Constant scoring rules as well as sequential constant scoring rules fail to satisfy Condorcet criteria when individual preferences are unrestricted. The purpose of this paper is to show that, if we assume that preferences are single-peaked, then some constant scoring rules satisfy the Condorcet loser criterion and some sequential constant scoring rules satisfy the Condorcet winner criterion. The results we provide make possible the identification of these rules.I thank Maurice Salles and two anonymous referees for their helpful comments. The usual disclaimers apply.     

Measurement distortion and missing contingencies in optimal contracts

Summary Theory suggests that optimal contracts should include many contingencies to achieve optimal risk sharing. However, in practice, few contracts are as complex as theory suggests. This paper develops a model which is consistent with this observation. The lack of risk sharing results from the interplay of two factors. First, contingencies must be based on information produced by measurement systems, which may be manipulable. Second, when two parties to a contract meet, they often have incomplete information. The type of contract offered may reveal information about the party who proposes it. Different types of agents have different preferences over contingent contracts, because they have different abilities to manipulate the measurement system. These differences in preferences allow the parties to signal their types through the contracts they offer. Noncontingent contracts may be chosen in equilibrium because they are the only contracts which do not give any type an incentive to distort the measurement system and, hence, do not reveal information about the party proposing the contract.We have benefited from conversations with Oliver Hart, Rick Lambert, Michael Riordan and Jean Tirole and the comments of Michel Habib, Nick Yannelis and two anonymous referees. Financial support from the National Science Foundation under grants SES-8920048 and SES-8720589 is gratefully acknowledged.     

Why banks should keep secrets

Summary. We show that it is sometimes efficient for a bank to commit to a policy that keeps information about its risky assets private. Our model, based upon Diamond-Dybvig (1983), has the feature that banks acquire information about their risky assets before depositors acquire it. A bank has the option of using contracts where the middle-period return on deposits is contingent on this information, but by doing so it must also reveal the information. We derive the conditions on depositors preferences and banking technology for which a bank would prefer to keep information secret even though it must then use a non-contingent deposit contract.Received: 5 November 2002, Revised: 19 December 2004, JEL Classification Numbers: D8, G21, G28.I would like to thank an anonymous referee, Sudipto Bhattacharya, Ed Green, Chandra Kanodia, Andy McLennan, Arijit Mukherji, Bradley Ruffle, Neil Wallace, Warren Weber, and especially Nobu Kiyotaki for useful comments and suggestions.     

Dynamic demand and noncompetitive pricing strategies

This paper studies optimal noncompetitive pricing strategies when the evolution of demand is the result of intertemporal considerations. Two different hypotheses of price expectations (myopia and perfect foresight) are treated. The major implication is that the slight modification from an instantaneous to a very fast consumer reaction may completely modify a monopolist's price strategy. More precisely, the price strategy should be volatile if the equilibrium demand is convex, independent whether the consumers act myopically or employ rational expectations. On the other hand, asynchronous dynamics (e.g., due to competitive fringe supply or different segments of demand) cannot explain even damped price oscillations. The equilibrium price strategy of the noncompetitive supplier exceeds the static rule if consumers employ myopic expectations; rational expectations may lead to prices above or below the static rule depending on the rate of discount.I am grateful for the helpful and elaborate comments from three anonymous referees.     

The optimality of nominal contracts

Summary. This paper presents a model in which agents choose to use money as a medium of exchange, a means of payment, and a unit of account. The paper defines conditions under which nominal contracts, promising future payment of a fixed number of units of fiat money, prove to be the optimal contract form in the presence of either relative or aggregate price risk. When relative prices are random, nominal contracts are optimal if individuals have ex ante similar preferences over future consumption. When the aggregate price level is random, whether from shocks to the money supply or aggregate output, nominal contracts (perhaps coupled with equity contracts) lead to optimal risk-sharing if individuals have the same degree of relative risk aversion. Finally, nominal contracts may be optimal if the repayment of contracts is subject to a binding cash-in-advance constraint. In this case, a contingent contract increases the risk of holding excessive cash balances. Received: March 29, 1996; revised version: February 25, 1997     

Employee types and endogenous organizational design: An experiment

When managers are sufficiently guided by social preferences, incentive provision through an organizational mode based on informal implicit contracts may provide a cost-effective alternative to a more formal mode based on explicit contracts and active monitoring. This paper reports the results from a stylized laboratory experiment designed to test whether subjects in the role of firm owner rely on the social preferences of other (‘employee’) subjects with whom they are matched when choosing which payoff version of a simple trust game these employee subjects should play (‘the organizational mode’). Our main finding is that they do so, albeit in a different way than theory predicts. The importance of the first mover's social preferences for trusting behavior is recognized by the owner subjects, but the significant (first order) impact second movers’ social preferences have on trusting behavior of first movers seems to be overlooked.     

Renegotiation in agency contracts, menus vs. simple contracts

The literature on contracts has shown that renegotiation in agency relationships generates efficiency losses when the principal leads the renegotiation. We show that contractual incompleteness may reduce such efficiency loss. This provides an explanation to the widespread use of simple contracts. We further point at the limited liability of the agent as a source of inefficiency when he leads the renegotiation; this latter result tempers the irrelevancy of contractual incompleteness demonstrated earlier in the literature. I thank E. Del Rey and the referees for their helpful comments and suggestions. Financial support from the EU RTN grant HPRN-CT-2000-00064 is gratefully acknowledged.     

Markets with infinitely many commodities and a continuum of agents with non-convex preferences

Summary Contrary to the finite dimensional set-up, the hypothesis of an atomless measure space of traders does not entail convexity of aggregate demand sets if there are infinitely many commodities. In this paper an assumption is introduced which sharpens the non-atomicity hypothesis by requiring that there are many agents of every type. When this condition holds, aggregate demand in an infinite dimensional setting becomes convex even if individual preferences are non-convex. This result is applied to prove the existence of competitive equilibria in such a context.Thanks to E. Dierker, K. Milford, M. Nermuth, C. Puppe, and N. Yannelis for comments and suggestions.     

Are bid preferences benign? The effect of small business subsidies in highway procurement auctions

Bid preferences in procurement auctions allow firms from an identifiable group an advantage in bidding against unfavored firms. While economic efficiency is expected to fall as a result of bid preferences, government procurement costs may either increase or decrease depending on the competitive response of favored and unfavored firms. This paper uses data from California auctions for road construction contracts, where small businesses receive a 5-percent bid preference in auctions for projects using only state funds and no preferential treatment on projects using federal aid. I show that while firms' bidding behavior matches theoretical predictions, procurement costs are 3.8 percent higher on auctions using preferences. The higher procurement cost in preference auctions is attributed to reduced participation by lower cost large firms.Structural estimates of latent firm costs are then used to evaluate how efficiency and the division of surplus between firms and the government are impacted by bid preferences. Firm profits are 3.1 percent lower under bid preferences, however this is overwhelmed by the efficiency loss due to reduced large firm participation. The efficiency loss conditional on firm participation is estimated to represent around 0.1 percent of overall procurement costs. Including the adverse effect of preferences on the participation of large firms increases the estimated efficiency loss to 3.6 percent, which represents 27 cents for each additional dollar awarded to small businesses through the program. Counterfactual simulations indicate that if participation were instead inelastic to bid preferences, the 5-percent bid preference would be close to the optimal level.     

Two-sided altruism, Lindahl equilibrium, and Pareto optimality in overlapping generations models

Summary. This paper extends the Samuelsonian overlapping generations general equilibrium framework to encompass a variety of altruistic preferences by recasting it into a Lindahl equilibrium framework. The First and the Second Welfare theorems hold for Lindahl equilibrium with respect to the Malinvaud optimality criterion but not with respect to the Pareto optimality criterion. A complete characterization of Pareto optimal allocations is provided using the Lindahl equilibrium prices.Received: 2 October 2003, Revised: 13 September 2004, JEL Classification Numbers: D51, D62, D64, C62.An earlier draft of the paper was prepared for presentation at the Sixth World Congress of the Econometric Society, 1990, Barcelona, Spain. Much of this work was done when I was at Yale University and University of California-San Diego. I am grateful to an anonymous referee of this journal and to Don Brown, Vince Crawford and Joel Sobel for many insightful comments and encouragements on an earlier draft of the paper.     

Nash equilibrium in games with incomplete preferences

Summary. This paper investigates Nash equilibrium under the possibility that preferences may be incomplete. I characterize the Nash-equilibrium-set of such a game as the union of the Nash-equilibrium-sets of certain derived games with complete preferences. These games with complete preferences can be derived from the original game by a simple linear procedure, provided that preferences admit a concave vector-representation. These theorems extend some results on finite games by Shapley and Aumann. The applicability of the theoretical results is illustrated with examples from oligopolistic theory, where firms are modelled to aim at maximizing both profits and sales (and thus have multiple objectives). Mixed strategy and trembling hand perfect equilibria are also discussed.Received: 22 September 2003, Revised: 24 June 2004, JEL Classification Numbers: D11, C72, D43.I would like to thank Jean-Pierre Benôit, Juan Dubra, Alejandrio Jofre, Debraj Ray, Kim-Sau Chung and the seminar participants at NYU and at the Universidad de Chile for their comments. I am most grateful to Efe Ok, for his comments, criticism, suggestions and questions.     

Information, bilateral negotiations, and worker recruitment

This paper studies experimentally how firms choose between using a centralized market and bilateral negotiations to recruit new personnel. In the market firms interact with several workers but do not have information about workers’ behavior in the past. In the bilateral negotiations firms negotiate bilaterally with prospective workers and learn about workers’ performance in previous jobs. We show that the interaction between social preferences, the incompleteness of contracts and the existence of information about a worker’s past performance provides an explanation for firms forgoing market opportunities and bilaterally negotiating with a worker. We observe that approximately 30% of all job contracts were bilaterally negotiated when these contracts are incomplete as opposed to only 10% when contracts were complete. The surplus from trade is higher when incomplete contracts can be bilaterally negotiated, which can be attributed to the presence of information.     

Regulation of network infrastructure investments: an experimental evaluation

This paper reports the results of an experiment evaluating three regulatory schemes for network infrastructure, in terms of their ability to generate efficient levels of capacity investment. We compare the performance of (1) price cap regulation, (2) a regulatory holiday for new capacity, and (3) price cap regulation with long term contracts combined with a secondary market. The setting is one in which network users can benefit from acting strategically, and are better informed than the network operator about demand growth. We find that the regulatory holiday creates an incentive to underinvest relative to optimal levels. Long term contracts also fail to improve on single price-cap regulation, and may reduce investment by providing noisier signals about future demand.     

Determinants of innovative activity in oligopolistic markets

This paper analyzes some important factors determining firms' innovative activity by using a dynamic stochastic oligopoly model. We suppose that the rivals in an industry maximize their expected discounted cash flows with respect to R&D expenditures and output levels. Optimal innovative activity is shown to depend positively on market size, but negatively on demand and technological uncertainty, spillovers, and interest rates. Using an isoelastic demand function, we can show that, if spillovers are modest and demand is relatively inelastic, firms' maximum innovative activity is not necessarily to be expected in the monopoly case. The maximum may also occur in either a duopoly or triopoly.Paper presented at the Annual Meeting of the Verein für Socialpolitik in Lugano, October 2–4, 1991. I would like to thank David Audretsch, Werner Güth, Ernst Helmstädter, Wolfgang Leininger, Manfred Neumann, Hans-Jürgen Ramser, Wolfram Richter, and Peter Zweifel for their helpful comments and suggestions. I am particularly indebted to three anonymous referees for many helpful suggestions. The financial support of the DFG in Bonn is gratefully acknowledged.     

Core and equilibrium in incomplete markets

Conclusions The classical foundation of general equilibrium analysis by the cooperative concept of the core has been extended to an economy with incomplete trading possibilities. This has been accomplished by restricting the exchange possibilities of coalitions of traders in accordance with the available market structure. However, compared with the classical result, the present foundation of rational expectations equilibria may appear much weaker. The reason is that in reality consumers may sign contracts which are more complex than the existing market structure. Therefore, it may happen that prices cannot decentralize all cooperative transactions by markets, in spite of perfect competition. With an incomplete set of markets, therefore, a cooperative exchange of commodities by individual contracts may coexist with trading in non-cooperative, competitive markets.I wish to thank Martin Hellwig for helpful comments and suggestions. Of course, I remain responsible for all shortcomings of the paper.     

Testing, hold up and the dynamics of preferences

This paper presents an overlapping generations model with cultural transmission of preferences in an economy in which players face a hold up problem. One of the players, the firm, can use a testing technology which allows him to imperfectly monitor his partner's behaviour. This technology is completely useless with homogeneous preferences. We obtain that in the stable steady state of the economy there is a mixed distribution of preferences where both selfish and other-regarding preferences are present in the population. Moreover, with a good testing technology, the steady state is characterized by the first-best result in the investment decisions. JEL Classification: C78, D23, D63 The authors acknowledge financial support from the Spanish Ministry of Science and Technology project SEC2001-2763. This paper has also benefited from comments of participants in the XXVIII Spanish Symposium of Economic Analysis in Seville (Spain), in the International Workshop on Social and Behavioral Economics in Valencia (Spain), in the 2nd World Congress of the Game Theory Society in Marseille and in the VI Spanish Meeting on Game Theory and Practice in Elche (Spain).