Production and insurance under regret aversion

This paper examines the behavior of a regret-averse producer facing revenue risk. To insure against the revenue risk, the producer can purchase a coinsurance contract with an endogenously chosen coinsurance rate. Regret-averse preferences are characterized by a utility function that includes disutility from having chosen ex-post suboptimal alternatives. We show that the regret-averse producer never fully insures against the revenue risk even though the coinsurance contract is actuarially fair. When the producer is sufficiently regret averse and the loss probability is high, we further show that the regret-averse producer chooses not to purchase the actuarially fair coinsurance contract. Even when purchasing the actuarially fair coinsurance contract is optimal, we derive sufficient conditions under which the regret-averse producer reduces the optimal output level as compared to that without the coinsurance contract. These results are distinct from those under pure risk aversion, thereby making the consideration of regret aversion crucial.     

Optimal sequential contract with a risk‐averse supplier

We study optimal contracts in environments where a risk‐averse supplier discovers cost information privately and gradually over time: the supplier is privately informed about its cost uncertainty at the time of contracting and discovers the realization of cost condition privately after contracting and before production. We show that both the buyer and the supplier prefer more cost uncertainty when the supplier is not very risk‐averse but less cost uncertainty when the supplier is sufficiently risk‐averse. However, the buyer always prefers to contract before the cost uncertainty resolves regardless of the supplier's degree of risk aversion. The nature of the optimal contract also depends on the supplier's risk preference. A separating contract is optimal when the supplier is not very risk‐averse; however, a pooling contract, which offers the same contract terms regardless of the cost uncertainty, can be optimal when the supplier becomes sufficiently risk‐averse. Moreover, the optimal production schedule is often characterized by “inflexible rules.”     

Regulation of a Risk Averse Firm

We extend the Laffont–Tirole regulation model to the case of risk-averse firms. Our main results are:

• The impact of risk aversion is to shift the optimal contract toward a cost-plus contract.

• As compared with the risk-neutral case, distortions are greater and informational rents are smaller.

• For high levels of risk aversion, the optimal contract involves cost ceilings and the less efficient firms are bunched together.

Journal of Economic LiteratureClassification Numbers: D8, L5.     

The role of risk aversion in public goods dilemmas with environmental uncertainty: an experimental analysis

The purpose of this study is to extend earlier research on environmental uncertainty in public goods dilemmas. The present paper reports the results of an experiment designed to examine the effect of risk aversion on public goods provision. A von Neumann–Morgenstern utility function with constant coefficient of relative risk aversion is used to investigate the impact of risk attitudes within a threshold public goods environment. The outcome of the threshold public goods experiment shows that subjects are indifferent to the changes in environmental conditions. Additionally, the analysis indicates that risk aversion is a significant determinant of voluntary public goods contribution level.     

Regulating a risk-averse firm under incomplete information

We examine the optimal regulatory policy for a risk-averse firm when the firm is imperfectly informed about its efficiency parameter for a project at the time of contracting. The firm’s risk aversion shifts the optimal regulatory policy from a fixed-price contract to a cost-plus contract. The optimal regulatory policy entails undereffort by an inefficient firm as in Laffont and Tirole (J Polit Econ 94(3):614–641, 1986) and the effort distortion increases as the firm becomes more risk-averse. Further, the regulator benefits from sequential contracting with the firm where the firm chooses contract terms gradually as it acquires information, albeit the benefit diminishes as the firm becomes more risk-averse.      

Risk Aversion and International Markets: Does Asset Trade Smooth Real Income?*

In a two-country model, complete asset markets do not guarantee that individuals will choose to eliminate all (diverifiable) risk in aggregate consumption. the presence of nontraded goods forces individuals to choose between reducing uncertainty in aggregate consumption and in the composition between traded and nontraded goods. This choice depends on a comparison of the standard coefficient of relative risk aversion with a second type of risk aversion that becomes relevant when nontraded goods are present, one that captures aversion to risk in composition. Regardless of the decision made, asset trade always reduces the risk premium.     

Optimal insurance design of ambiguous risks

We examine the characteristics of the optimal insurance contract under linear transaction costs and an ambiguous distribution of losses. Under the standard expected utility model, we know from Arrow (1965) that it contains a straight deductible. In this paper, we assume that the policyholder is ambiguity averse in the sense of Klibanoff et al. (Econometrica 73(6):1849–1892, 2005). The optimal contract depends upon the structure of the ambiguity. For example, if the set of possible priors can be ranked according to the monotone likelihood ratio order, the optimal contract contains a disappearing deductible. We also show that the policyholder’s ambiguity aversion may have the counterintuitive effect to reduce the optimal insurance coverage of an ambiguous risk.     

Incentives and Transactions Costs Within the Firm: Estimating an Agency Model Using Payroll Records

We estimate an agency model using the payroll records of a copper mine that paid a production bonus to teams of workers. We estimate the cost of incomplete information due to insurance and incentives considerations and the inefficiency caused by the simple form of the incentive contract itself. At the estimated parameters the cost of worker risk aversion (insurance) is of similar magnitude to moral hazard (incentives). Overall, incomplete information accounted for one-half of the bonus system's inefficiency relative to potential full information profits. The other half is attributed to the bonus system's inefficient generation of incentives and insurance relative to the optimal incentive contract.     

Optimal contract mechanisms for principal-agent problems with moral hazard and adverse selection

Summary We examine the problem of incentive compatibility and mechanism design for incomplete information principal-agent problems. Allowing for risk aversion on the part of the principal and agent, we show the existence of an optimal, incentive compatible contract selection mechanism for the principal under conditions of moral hazard and adverse selection. Since we assume that the contract set is a function space of state contingent contracts, and that the set of agent types is uncountable, the set of contract selection mechanisms becomes infinite dimensional. Hence, novel existence arguments are required. Our existence result extends those of Grossman and Hart [10] and Page [23] to an infinite dimensional setting with incomplete information.     

Dynamic Moral Hazard and Executive Stock Options

This paper shows that the optimal executive compensation scheme in a dynamic moral hazard environment is convex in the firm value. This implies that the optimal contract should include stock options. This is because the private benefit of shirking is increasing in firm value and the manager's utility is concave. Therefore, in contrast to the previous literature that takes stock options in the incentive contract exogenously, we rationalize the optimality of their use endogenously. Moreover, we show that the optimal amount of stock options (restricted stocks) increases with agency cost and the executive's reservation utility, decreases with the degree of risk aversion of the manager, and increases (decreases) with the firm size.     

Exploration Versus Extraction Costs as Determinants of Optimal Mineral-Rights Leases*

Leasing agreements concerning the exploitation of mineral deposits on government lands are analyzed with a special emphasis on the distinction between exploration and extraction activities. Results include a demonstration that the conditions for the optimal sharing of exploration costs are closely related to the conditions for the optimal pricing of public goods. Other results include a demonstration of how the sharing of exploration costs relative to the sharing of production costs is affected by asymmetries in information as well as by differences in risk aversion.     

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.     

Providing global public goods under uncertainty

We study how uncertainty and risk aversion affect international agreements to supply global public goods. We consider a benchmark model with homogeneous countries and linear payoffs. When countries directly contribute to a public good, uncertainty tends to lower signatories' efforts but may increase participation. Despite risk aversion, uncertainty may improve welfare. In contrast, when countries try to reduce a global public bad, uncertainty tends to increase signatories' efforts and decrease participation. In that case, an ex-ante reduction of uncertainty may have a large positive multiplier effect on welfare.     

Layoffs,wages and unemployment insurance

The influence of unemployment insurance on wage and layoff behavior is analyzed in the context of optimal labor contracts. Responses of contract terms to changes in economic parameters are shown to depend in general on the nature of the initial contract, the degree of workers' risk aversion, and the resolution of bargaining conflict. Layoffs are not necessarily reduced by an increase in experience rating or a reduction in the UI benefit. Product demand fluctuations tend to induce procyclical employment fluctuations but not wage fluctuation. An implication of optimal contracts with private insurance suggests a reason for government intervention in UI provision.     

Rotating Savings and Credit Associations When Participants are Risk Averse*

We model rotating savings and credit associations (Roscas) among risk‐averse participants who experience privately observed income shocks. A random Rosca is not advantageous, whereas a bidding Rosca is if temporal risk aversion is less pronounced than static risk aversion. The payoff scheme of a bidding Rosca facilitates risk sharing in the presence of information asymmetries. The risk‐sharing performance of a simple arrangement where a group of homogenous individuals runs several bidding Roscas simultaneously is as good as that of a linear risk‐sharing contract, and is more enforceable because it carries a fixed rather than a variable contribution.     

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     

Risk aversion and optimal reserve prices in first- and second-price auctions

We analyze the effects of buyer and seller risk aversion in first- and second-price auctions in the classic setting of symmetric and independent private values. We show that the seller's optimal reserve price decreases in his own risk aversion, and more so in the first-price auction. The reserve price also decreases in the buyers' risk aversion in the first-price auction. Thus, greater risk aversion increases ex post efficiency in both auctions - especially that of the first-price auction. At the interim stage, the first-price auction is preferred by all buyer types in a lower interval, as well as by the seller.     

Optimal Design of Forest Taxation with Multiple-Use Characteristics of Forest Stands

The paper studies optimal forest taxation under uncertainty about future timber price when private forest owners value amenity services of forest stands and forest stands have public goods characteristics. It is assumed that preferences of forest owners can be described by a quasi-linear, intertemporal utility function which reflects risk aversion in terms of consumption and constant marginal utility in terms of amenity services. The comparative statics of current and future harvesting in terms of timber price risk, site productivity tax and yield tax are first developed. It is shown that, given the optimal site productivity tax, which is independent of the timber harvested and thus non-distortionary, it is desirable to introduce the yield tax at the margin; it both corrects externality due to the public goods characteristic of forest stands and serves as a social insurance device. The optimal yield tax is less than 100% and depends on the social value of forest stands, timber price risk and properties of compensated timber supply. In the general case the 'inverse elasticity rule – according to which the optimal yield tax is negatively related to the size of the substitution effects – may not hold. Under certainty, the desirability of the yield tax, given the optimal site productivity tax, depends only on the existence of public goods characteristic and is thus a pure Pigouvian tax.     

Does the Optimal Size of a Fish Stock Increase with Environmental Uncertainties?

We analyze the effect of environmental uncertainties on optimal fishery management in a bio-economic fishery model. Unlike most of the literature on resource economics, but in line with ecological models, we allow the different biological processes of survival and recruitment to be affected differently by environmental uncertainties. We show that the overall effect of uncertainty on the optimal size of a fish stock is ambiguous, depending on the prudence of the value function. For the case of a risk-neutral fishery manager, the overall effect depends on the relative magnitude of two opposing effects, the ‘convex-cost effect’ and the ‘gambling effect’. We apply the analysis to the Baltic cod and the North Sea herring fisheries, concluding that for risk neutral agents the net effect of environmental uncertainties on the optimal size of these fish stocks is negative, albeit small in absolute value. Under risk aversion, the effect on optimal stock size is positive for sufficiently high coefficients of constant relative risk aversion.     

私募股权投资基金薪酬合约的激励机制研究

利用合约经济学的分析方法研究私募股权投资基金的薪酬合约,我们发现:在不对称信息下创业投资家的道德风险会造成显著的代理成本.并且私募基金管理的代理成本与创业投资家的能力、风险厌恶程度以及私募股权投资基金投资组合的风险正相关;同时我们发现在私募股权投资基金的薪酬合约中引入创业板市场的景气状况作为投资组合收益的基准可显著提高创业投资家的努力激励,并显著降低私募股权投资基金管理的代理成本.