Incentive Contracting Under Limited Liability

We examine the nature of incentive schemes between the principal and the risk-neutral agent in the presence of the agent's limited liability and ex ante action choice. We consider alternative schemes when a simple rental contract is infeasible due to the limited liability of the agent and study the effectiveness of a performance bonus scheme in achieving the first-best outcome. We also discuss some implications of such schemes in real practices.     

Optimal Contracts for Long-Term Decisions and the Threat of Dismissal

This paper studies a simple agency model where an agent's decision can affect his or her own future payoffs as well as the principal's. The threat of dismissal becomes an important part of an incentive scheme even if the principal can use the performance-based wage contract. However, if the agent's future payoffs depend on the past realized performance, but not on the past decision directly, or if the agent is risk-neutral, it is not optimal to use the threat of dismissal. As the agent's discretion over his future payoffs increases, the principal relies more on the threat of dismissal but less on the wage contract.     

Managerial Incentives Based on Acquisition of Information

In a moral hazard setting, we model the fact that the agent may get private signals about the final outcome of his effort before the public realization of this outcome. Actions affect both the distribution of the outcome and the quality of the agent's private information. We compare simple contracts, based on output only, with revelation contracts, based on output and messages about signals. Revelation contracts give the agent some discretionary power during the course of the relationship; they are optimal if and only if lowering effort does not increase the quality of private information in the sense of Blackwell (1953). In the context of managerial compensation schemes, the revelation contracts we analyze can be viewed as allowing the agent to exercise an option on the final profits before the realization of these profits. The theory thus provides an alternative justification of the widespread use of stock options in managerial compensation schemes, as opposed to compensation schemes that rely only on salary, bonus, and (restricted) stock plans.     

Task Assignmentand Agency Structures

This paper considers an agency model in which a principal delegates an agent authority to choose investment projects. The performance of the project depends stochastically on the agent's evaluation and operating efforts. The paper examines the conditions under which the principal prefers to assign production to a second agent. It is shown that the tasks will be assigned to two agents of the agent chooses an unobservable operating effort. The tasks will be assigned to one agent if the agent's evaluation and operating efforts are both unobservable and if disutilities of efforts are large relative to the profit from the risky project.     

Survival in Cournot games

In a model that encompasses a general equilibrium framework, we consider a monopolist (a producer) with subjective beliefs that endogenously hedges against fluctuations in input prices in a complete market. We allow for entries and Cournot competition in this economy, and we study how erroneous beliefs affect long-run survival for those firms. We introduce a notion of entropy of beliefs, and we use it to characterize the class of beliefs for which the monopolist eventually disappears almost surely. When disappearance occurs, the whole market power switches to the entrant making the most accurate predictions in our sense. The class of beliefs for which survival occurs is much broader than that of perfectly competitive settings.     

Collusive Market Sharing and Corruption in Procurement

This paper investigates links between corruption and collusion in procurement. A first-price multiple-object auction is administered by an agent who has legal discretion to allow for a readjustment of (all) submitted offers before the official opening. The agent may be corrupt, that is, willing to "sell" his decision in exchange for a bribe. Our main result shows that the corrupt agent's incentives to extract rents are closely linked with that of a cartel of bidders. First, collusive bidding conveys value to the agent's decision power. Second, self-interested abuse of discretion to extract rents (corruption) provides a mechanism to enforce collusion. A second result is that package bidding can facilitate collusion. We also find that with corruption, collusion is more likely in auctions where firms are small relative to the market. Our main message to auction designers, competition authorities and criminal courts is that risks of collusion and of corruption must be addressed simultaneously. Some other policy implications for the design of tender procedures are discussed.     

Bargaining over an uncertain outcome:¶the role of beliefs

We study the Nash bargaining solution of a problem in which two agents bargain over an uncertain outcome. Under the assumptions of risk neutrality and of constant absolute risk aversion, we study the way that the solution varies, ex ante, when we vary the beliefs of one agent. Changing an agent's beliefs in a way that makes them “more distant” from the other agent's beliefs makes the second agent better off. Received: 10 May 2001 / Accepted: 22 August 2001     

The Ignored Performance Measure

This paper studies a setting in which a risk-averse agent must be motivated to work on two tasks: evaluating a potential project and, if the project is adopted, implementing it. Although a performance measure that is informative of an agent's action is typically valuable because it can be used to improve the risk sharing of the contract, this is not necessarily the case in this two-task setting. I provide a sufficient condition under which a performance measure that is informative of the agent's implementation effort is worthless for contracting despite the agent being risk averse. This shows that information content is a necessary but not a sufficient condition for a performance measure to be valuable.     

Market clearing by maximum entropy in agent models of stock markets

We replace the conventional market clearing process by maximizing the information entropy. At fixed return agents optimize their demands using an utility with a statistical tolerance against deviations from the deterministic maximum of the utility which leads to information entropies for the agents. Interactions are described by coupling the agents to a large system, called ‘market’. The main problem in economic markets is the absence of the analogue of the first law of thermodynamics (energy conservation in physics). We solve this problem by restricting the utilities to be at most quadratic in the demand (ideal gas approximation). Maximizing the sum of agent and market entropy serves to eliminate the unknown properties of the latter. Assuming a stochastic volatility decomposition for the return we derive an expression for the pdf of the return which is in excellent agreement with the daily DAX data. The pdf exhibits a power law behaviour with an integer tail index equal to the number of agent groups. With the assumption of an Ornstein Uhlenbeck model for the risk aversity parameters of the agents the autocorrelation for the absolute return is well described up to time lags of 2.5 years.     

Asset pricing with endogenous aspirations

We develop the classical asset pricing analysis assuming that the representative agent is characterized by endogenous aspirations. The agent's aspirations at time t are given by a linear combination of the standard of living (habit) at time t (the "forward" part) and of the conditional expectation at t of the habit at the end of the agent's life (the "backward" part). With this process we capture the fact that the agent's preferences are affected by what he plans to do in the future. Under certain conditions, the risk premium turns out to be higher than that obtained with an additive expected utility when both the forward and the backward parts affect the utility negatively.     

Which one should I imitate?

An individual repeatedly faces the same decision. Payoffs generated by his available actions are noisy. This individual forgets earlier experience and is limited to learn by observing current success of two other individuals. We select among behavioral rules that lead an infinite population of identical individuals in the long run to the expected payoff maximizing action. Optimal behavior requires learning by imitation. The second most successful in a sample must sometimes be imitated although the most successful will always be imitated with a higher probability. Inertia is optimal. When each individual follows an optimal rule, then the population evolves according to an aggregate monotone dynamic.     

Stochastic stability in assignment problems

In a dynamic model of assignment problems, it is shown that small deviations suffice to move between stable outcomes. This result is used to obtain no-selection and almost-no-selection results under the stochastic stability concept for uniform and payoff-dependent errors. There is no-selection of partner or payoff under uniform errors, nor for agents with multiple optimal partners under payoff-dependent errors. There can be selection of payoff for agents with a unique optimal partner under payoff-dependent errors. However, when every agent has a unique optimal partner, almost-no-selection is obtained.     

Subgame-perfect equilibria in stochastic timing games

We develop a notion of subgames and the related notion of subgame-perfect equilibrium – possibly in mixed strategies – for stochastic timing games. To capture all situations that can arise in continuous-time models, it is necessary to consider stopping times as the starting dates of subgames. We generalize Fudenberg and Tirole’s (Rev. Econom. Stud. 52, 383–401, 1985) mixed-strategy extensions to make them applicable to stochastic timing games and thereby provide a sound basis for subgame-perfect equilibria of preemption games. Sufficient conditions for equilibrium existence are presented, and examples illustrate their application as well as the fact that intuitive arguments can break down in the presence of stochastic processes with jumps.     

Context dependent beliefs

This paper examines a model where the set of available outcomes from which a decision maker must choose alters his perception of uncertainty. Specifically, this paper proposes a set of axioms such that each menu induces a subjective belief over an objective state space. The decision maker’s preferences are dependent on the realization of the state. The resulting representation is analogous to state-dependent expected utility within each menu; the beliefs are menu dependent and the utility index is not. Under the interpretation that a menu acts as an informative signal regarding the true state, the paper examines the behavioral restrictions that coincide with different signal structures: elemental (where each element of a menu is a conditionally independent signal) and partitional (where the induced beliefs form a partition of the state space).     

Information Measures in Perspective

Information-theoretic methodologies are increasingly being used in various disciplines. Frequently an information measure is adapted for a problem, yet the perspective of information as the unifying notion is overlooked. We set forth this perspective through presenting information-theoretic methodologies for a set of problems in probability and statistics. Our focal measures are Shannon entropy and Kullback–Leibler information. The background topics for these measures include notions of uncertainty and information, their axiomatic foundation, interpretations, properties, and generalizations. Topics with broad methodological applications include discrepancy between distributions, derivation of probability models, dependence between variables, and Bayesian analysis. More specific methodological topics include model selection, limiting distributions, optimal prior distribution and design of experiment, modeling duration variables, order statistics, data disclosure, and relative importance of predictors. Illustrations range from very basic to highly technical ones that draw attention to subtle points.     

Eliciting the socially optimal allocation from responsible agents

We consider designing a mechanism to allocate objects among agents without monetary transfers. There is a socially optimal allocation, which is commonly known by the agents but not observable by the designer. The designer possibly has information about the existence of responsible agents. A responsible agent, when indifferent between his objects at two different allocations, prefers the first allocation to the second if the first allocation is closer to the optimal allocation than the second, in the sense that all the agents who are allocated their optimal objects in the second allocation are allocated their optimal objects also in the first allocation, and there is at least one more agent in the first allocation receiving his optimal object. We show that, if the designer knows that there are at least three responsible agents, even if the identities of the responsible agents are not known, the optimal allocation can be elicited.     

Using Subjective Risk Adjusting to Prevent Patient Dumping in the Health Care Industry

We examine how to procure health care services at minimum cost while preventing suppliers from refusing to care for high-cost patients. A single risk-adjusted prospective payment is optimal only when it is particularly costly for the supplier to discover likely treatment costs. Cost sharing is optimal when these screening costs are somewhat smaller. When screening costs are sufficiently small, screening is optimally accommodated and subjective risk adjusting is implemented. Under subjective risk adjusting, the supplier classifies patients according to his personal assessment of likely treatment costs, and payments are structured accordingly. Optimal procurement policies are contrasted with prevailing industry policies.     

Dynamic discrete choice and dynamic treatment effects

This paper considers semiparametric identification of structural dynamic discrete choice models and models for dynamic treatment effects. Time to treatment and counterfactual outcomes associated with treatment times are jointly analyzed. We examine the implicit assumptions of the dynamic treatment model using the structural model as a benchmark. For the structural model we show the gains from using cross-equation restrictions connecting choices to associated measurements and outcomes. In the dynamic discrete choice model, we identify both subjective and objective outcomes, distinguishing ex post and ex ante outcomes. We show how to identify agent information sets.