One of the main results of “Robust Contract Designs: Linear Contracts and Moral Hazard” by Yu and Kong (2020) is Proposition 4, which states that the optimal robust contract with a piecewise linear concave agent utility only consists of progressive fixed payments and linear rewards with progressive commission rates. In this note, we construct a counterexample showing that this result is wrong.
{"title":"Error Noted in “Robust Contract Designs: Linear Contracts and Moral Hazard” by Yu and Kong (2020)","authors":"Jingyuan Yang, Linwei Xin","doi":"10.2139/ssrn.3895883","DOIUrl":"https://doi.org/10.2139/ssrn.3895883","url":null,"abstract":"One of the main results of “Robust Contract Designs: Linear Contracts and Moral Hazard” by Yu and Kong (2020) is Proposition 4, which states that the optimal robust contract with a piecewise linear concave agent utility only consists of progressive fixed payments and linear rewards with progressive commission rates. In this note, we construct a counterexample showing that this result is wrong.","PeriodicalId":285784,"journal":{"name":"ERN: Economics of Contract: Theory (Topic)","volume":"6 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2021-07-29","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"122041644","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
In recent years a platform economy has emerged that is dominated by undertakings such as Google, Amazon, Facebook, Apple and Microsoft. They have established a form of private governance vis-a-vis their consumers and customers by means of standard terms that create a risk of exploitation. This trend clashes with the internal market effort of the EU that is predicated on consumer rights and fair competition to address market failures such as market power, information asymmetry and asymmetrical contractual dependency. In this article we examine how the resulting tensions can be addressed by means of EU competition and contract law. This is based on enforcing fairness by requiring (i) the implementation of proportionality – balancing interests – and (ii) respect of the duty of care, in the sense of compliance by design. Jointly this can be seen as an expression of accountability that needs to be made explicit. Apart from pre-existing case law and legislation we take into account the December 2020 Commission proposals for platform regulation, as well as behavioral insights into consumer behavior.
{"title":"Fair Private Governance for the Platform Economy: EU Competition and Contract Law Applied to Standard Terms","authors":"J. Rutgers, W. Sauter","doi":"10.2139/ssrn.3859941","DOIUrl":"https://doi.org/10.2139/ssrn.3859941","url":null,"abstract":"In recent years a platform economy has emerged that is dominated by undertakings such as Google, Amazon, Facebook, Apple and Microsoft. They have established a form of private governance vis-a-vis their consumers and customers by means of standard terms that create a risk of exploitation. This trend clashes with the internal market effort of the EU that is predicated on consumer rights and fair competition to address market failures such as market power, information asymmetry and asymmetrical contractual dependency. In this article we examine how the resulting tensions can be addressed by means of EU competition and contract law. This is based on enforcing fairness by requiring (i) the implementation of proportionality – balancing interests – and (ii) respect of the duty of care, in the sense of compliance by design. Jointly this can be seen as an expression of accountability that needs to be made explicit. Apart from pre-existing case law and legislation we take into account the December 2020 Commission proposals for platform regulation, as well as behavioral insights into consumer behavior.","PeriodicalId":285784,"journal":{"name":"ERN: Economics of Contract: Theory (Topic)","volume":"3 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2021-06-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"121469617","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
We propose a family of incentive contracts that can attract some fund managers who are favored by investors and deter any manager who is unfavorable to some investors. The contract problem has hidden types, hidden actions, hidden knowledge of preferences, and opportunity cost. In contrast to standard screening contracts, our contracts neither depend explicitly on the utilities of the managers and investors nor have a menu of choices. The contracts have two crucial components: (i) a first- loss deposit to be used to offset some of the principal’s losses and (ii) a liquidation boundary. A case study is also given.
{"title":"Menuless and Preference-Free Screening Contracts for Fund Managers","authors":"X. He, Sang Hu, S. Kou","doi":"10.2139/ssrn.3856785","DOIUrl":"https://doi.org/10.2139/ssrn.3856785","url":null,"abstract":"We propose a family of incentive contracts that can attract some fund managers who are favored by investors and deter any manager who is unfavorable to some investors. The contract problem has hidden types, hidden actions, hidden knowledge of preferences, and opportunity cost. In contrast to standard screening contracts, our contracts neither depend explicitly on the utilities of the managers and investors nor have a menu of choices. The contracts have two crucial components: (i) a first- loss deposit to be used to offset some of the principal’s losses and (ii) a liquidation boundary. A case study is also given.","PeriodicalId":285784,"journal":{"name":"ERN: Economics of Contract: Theory (Topic)","volume":"71 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2021-05-30","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"127265368","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Kyoung Jin Choi, Junkee Jeon, Ho-Seok Lee, Hsuan-Chih Lin
We study an optimal long-term labor contract that provides disability insurance benefits under two frictions: the agent cannot commit to a long-term contract and the disability shock is private information. We predict that a job with a high risk of disability should provide a higher level of salary but with a lower growth rate over time. We find that the optimal contract can be implemented under a three-account trading system in which mandatory savings can be imposed to discourage a worker from falsely claiming disability. We also investigate how the nature of disability shock has an impact on the optimal contract: a larger borrowing limit should be given to a worker with a high severity of the disability shock or a low arrival intensity. Finally, our quantitative analysis shows that the cost caused by current long-term disability insurance practice can be substantial.
{"title":"Optimal Long-term Contracts with Disability Insurance under Limited Commitment","authors":"Kyoung Jin Choi, Junkee Jeon, Ho-Seok Lee, Hsuan-Chih Lin","doi":"10.2139/ssrn.3421296","DOIUrl":"https://doi.org/10.2139/ssrn.3421296","url":null,"abstract":"We study an optimal long-term labor contract that provides disability insurance benefits under two frictions: the agent cannot commit to a long-term contract and the disability shock is private information. We predict that a job with a high risk of disability should provide a higher level of salary but with a lower growth rate over time. We find that the optimal contract can be implemented under a three-account trading system in which mandatory savings can be imposed to discourage a worker from falsely claiming disability. We also investigate how the nature of disability shock has an impact on the optimal contract: a larger borrowing limit should be given to a worker with a high severity of the disability shock or a low arrival intensity. Finally, our quantitative analysis shows that the cost caused by current long-term disability insurance practice can be substantial.","PeriodicalId":285784,"journal":{"name":"ERN: Economics of Contract: Theory (Topic)","volume":"11 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2021-01-28","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"117029103","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
We develop a model wherein a risk-neutral but ambiguity-averse principal contracts with a risk-averse agent who has a risky project. Both the agent and the principal can observe the project output and a public signal. The correlation between the output and the public signal is private information to the agent but is an ambiguous random variable to the principal. Then, apart from moral hazard, the optimal contract takes into consideration both adverse selection and ambiguity aversion simultaneously. Due to the classic trade-off between rent and efficiency, the principal lowers contract power for the agent with a low correlation project (the l-type agent) and compensates her for luck. However, aversion to correlation ambiguity counteracts with this rent reducing effect by making the principal weight the l-type agent more. Consequently, although ambiguity lessens the principal's value, it could improve social welfare by increasing efficiency of the l-type agent. We further extend the model by incorporating an aggregate signal whose variance depends on the ambiguous distribution of all the projects and allowing the agents to be ambiguity-averse. In this case, the principal has to respect the agent's model choice and compensates her for ambiguity premium, which again decreases contract power. With ambiguity-sharing, the pair of optimal separating contracts is metamorphosed compared to those in the baseline model.
{"title":"Performance Evaluation under Adverse Selection and Correlation Ambiguity","authors":"Yu Huang, Ning Zhang","doi":"10.2139/ssrn.3755190","DOIUrl":"https://doi.org/10.2139/ssrn.3755190","url":null,"abstract":"We develop a model wherein a risk-neutral but ambiguity-averse principal contracts with a risk-averse agent who has a risky project. Both the agent and the principal can observe the project output and a public signal. The correlation between the output and the public signal is private information to the agent but is an ambiguous random variable to the principal. Then, apart from moral hazard, the optimal contract takes into consideration both adverse selection and ambiguity aversion simultaneously. Due to the classic trade-off between rent and efficiency, the principal lowers contract power for the agent with a low correlation project (the l-type agent) and compensates her for luck. However, aversion to correlation ambiguity counteracts with this rent reducing effect by making the principal weight the l-type agent more. Consequently, although ambiguity lessens the principal's value, it could improve social welfare by increasing efficiency of the l-type agent. We further extend the model by incorporating an aggregate signal whose variance depends on the ambiguous distribution of all the projects and allowing the agents to be ambiguity-averse. In this case, the principal has to respect the agent's model choice and compensates her for ambiguity premium, which again decreases contract power. With ambiguity-sharing, the pair of optimal separating contracts is metamorphosed compared to those in the baseline model.","PeriodicalId":285784,"journal":{"name":"ERN: Economics of Contract: Theory (Topic)","volume":"19 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2020-12-25","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"125985222","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
In this study, I theoretically analyze fake reviews on a platform market using models where a seller creates fake reviews through incentivized transactions, and its sales depend on its rating based on a review history. The platform can control the incentive for fake reviews by changing the parameters of the rating system, such as its filtering policy and weights, for past reviews. At equilibrium, the number of fake reviews increases as quality increases but decreases as reputation improves. Since fake reviews have a positive relationship with a product’s underlying quality, under some parameters, rational consumers find a rating more informative when fake reviews exist, while credulous consumers suffer from a bias caused by boosted reputation. A stringent filtering policy can decrease the expected amount of fake reviews and the bias of credulous consumers, but at the same time, it can decrease the informativeness of a rating system for rational consumers. In terms of the weight placed on the review history, rational consumers benefit from higher weights on past reviews than from optimal weights without fake reviews.
{"title":"Controlling Fake Reviews","authors":"Yuta Yasui","doi":"10.2139/ssrn.3693468","DOIUrl":"https://doi.org/10.2139/ssrn.3693468","url":null,"abstract":"In this study, I theoretically analyze fake reviews on a platform market using models where a seller creates fake reviews through incentivized transactions, and its sales depend on its rating based on a review history. The platform can control the incentive for fake reviews by changing the parameters of the rating system, such as its filtering policy and weights, for past reviews. At equilibrium, the number of fake reviews increases as quality increases but decreases as reputation improves. Since fake reviews have a positive relationship with a product’s underlying quality, under some parameters, rational consumers find a rating more informative when fake reviews exist, while credulous consumers suffer from a bias caused by boosted reputation. A stringent filtering policy can decrease the expected amount of fake reviews and the bias of credulous consumers, but at the same time, it can decrease the informativeness of a rating system for rational consumers. In terms of the weight placed on the review history, rational consumers benefit from higher weights on past reviews than from optimal weights without fake reviews.","PeriodicalId":285784,"journal":{"name":"ERN: Economics of Contract: Theory (Topic)","volume":"1 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2020-09-21","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"130658881","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
This paper studies an optimal insurance problem with finitely many potential policyholders. A monopolistic, risk-neutral insurer offers an insurance contract, and exponential utility maximizing individuals accept the offer or not. We allow for heterogeneity in the preferences of the individuals, while the insurer cannot discriminate in the insurance premium. We show that it is optimal for the insurer to offer only a full insurance contract, and the price optimization problem is reduced to a discrete problem, where the premium is an indifference premium for one individual in the market. Moreover, if individuals can self-select their insurance coverage given the market premium rate, then we find that partial insurance is generally optimal. Since the risk aversion parameters of individuals is generally unobserved, we also present a simulation-based framework. We show its convergence, and provide numerical examples.
{"title":"Insurance With Heterogeneous Preferences","authors":"T. Boonen, Fangda Liu","doi":"10.2139/ssrn.3677285","DOIUrl":"https://doi.org/10.2139/ssrn.3677285","url":null,"abstract":"This paper studies an optimal insurance problem with finitely many potential policyholders. A monopolistic, risk-neutral insurer offers an insurance contract, and exponential utility maximizing individuals accept the offer or not. We allow for heterogeneity in the preferences of the individuals, while the insurer cannot discriminate in the insurance premium. We show that it is optimal for the insurer to offer only a full insurance contract, and the price optimization problem is reduced to a discrete problem, where the premium is an indifference premium for one individual in the market. Moreover, if individuals can self-select their insurance coverage given the market premium rate, then we find that partial insurance is generally optimal. Since the risk aversion parameters of individuals is generally unobserved, we also present a simulation-based framework. We show its convergence, and provide numerical examples.","PeriodicalId":285784,"journal":{"name":"ERN: Economics of Contract: Theory (Topic)","volume":"16 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2020-08-15","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"124882845","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
We consider a relational contracting model in which the parties choose to allocate authority either to the principal (centralization) or to the agent (delegation). The party who has authority chooses a project, and the agent exerts effort to successfully execute the project. Delegation generates (i) a positive effect to motivate the agent to exert effort through credible choice of the agent's favoured project; and (ii) a negative effect that induces an inefficient project to avoid the agent's deviation to his favourite project. Consequently, delegation is inclined to be optimal for the parties with low discount factors.
{"title":"Managing Authority and Incentives in Relational Contracts","authors":"A. Ishihara","doi":"10.2139/ssrn.3551035","DOIUrl":"https://doi.org/10.2139/ssrn.3551035","url":null,"abstract":"We consider a relational contracting model in which the parties choose to allocate authority either to the principal (centralization) or to the agent (delegation). The party who has authority chooses a project, and the agent exerts effort to successfully execute the project. Delegation generates (i) a positive effect to motivate the agent to exert effort through credible choice of the agent's favoured project; and (ii) a negative effect that induces an inefficient project to avoid the agent's deviation to his favourite project. Consequently, delegation is inclined to be optimal for the parties with low discount factors.","PeriodicalId":285784,"journal":{"name":"ERN: Economics of Contract: Theory (Topic)","volume":"20 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2020-07-22","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"117045445","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
We present a model in which the agent reports a privately observed signal about the stochastic outcome of her action, while bearing a cost of misreporting her private information. If the agent receives a low payment contingent on her performance, it is very costly for the agent to misreport her information to the principal so that the principal makes a decision favorable to the agent. However, if the contingent compensation is too high, the principal will terminate the project unless the agent truthfully reports that the project is likely to give a high return. The optimal outcome is achieved by a contract with the fee structure loosely tied with the outcome, but the cost of lying is necessarily high.
{"title":"Optimal Contracts under Moral Hazard and Costly Lying","authors":"Kee-Choon Rhee","doi":"10.2139/ssrn.3537308","DOIUrl":"https://doi.org/10.2139/ssrn.3537308","url":null,"abstract":"We present a model in which the agent reports a privately observed signal about the stochastic outcome of her action, while bearing a cost of misreporting her private information. If the agent receives a low payment contingent on her performance, it is very costly for the agent to misreport her information to the principal so that the principal makes a decision favorable to the agent. However, if the contingent compensation is too high, the principal will terminate the project unless the agent truthfully reports that the project is likely to give a high return. The optimal outcome is achieved by a contract with the fee structure loosely tied with the outcome, but the cost of lying is necessarily high.","PeriodicalId":285784,"journal":{"name":"ERN: Economics of Contract: Theory (Topic)","volume":"5 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2020-06-25","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"133396574","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
This paper studies the role of information design in facilitating trust and trustworthiness. We consider a trust game with spatial matching by Okada (2019). In this trust game, both players begin with the psychological benefits of good practice (cooperation), but the psychological benefits for an investor (the first player) trusting a receiver (the second player) and those for the receiver behaving in a trustworthy manner both decrease as their social distance widens. We compute Bayes correlated equilibria (Bergemann and Morris, 2016), a set of mild suggestions (strategies) the players obediently follow in equilibrium, and then pin down the optimal suggestion that will, with the largest probability, induce good practice. Comparison with the Bayes Nash equilibrium outcomes (analysis of trust games without suggestions) reveals interesting contrasts. With optimal suggestions, we can increase good practice given the same level of affinities among the players. In addition, we investigate whether the optimal suggestion rule hampers the cultural transmission of trust and trustworthiness. To test this, we consider a pair composed of a parent and a child and allow the parent to exert educational effort for moral development of the child. Transmission of cultural norms is hampered if the parents exert less effort with the suggestion rule, so the question becomes how to motivate parents to exert more effort. Our analysis helps to understand the impact of the suggestion rule on trust and trustworthiness, particularly in the current digital economy where such suggestion rules are prevalent and trust and trustworthiness play a key role to sustain the economics.
{"title":"The Role of Information Design in Facilitating Trust and Trustworthiness","authors":"Saori Chiba, Michiko Ogaku","doi":"10.2139/ssrn.3529150","DOIUrl":"https://doi.org/10.2139/ssrn.3529150","url":null,"abstract":"This paper studies the role of information design in facilitating trust and trustworthiness. We consider a trust game with spatial matching by Okada (2019). In this trust game, both players begin with the psychological benefits of good practice (cooperation), but the psychological benefits for an investor (the first player) trusting a receiver (the second player) and those for the receiver behaving in a trustworthy manner both decrease as their social distance widens. We compute Bayes correlated equilibria (Bergemann and Morris, 2016), a set of mild suggestions (strategies) the players obediently follow in equilibrium, and then pin down the optimal suggestion that will, with the largest probability, induce good practice. Comparison with the Bayes Nash equilibrium outcomes (analysis of trust games without suggestions) reveals interesting contrasts. With optimal suggestions, we can increase good practice given the same level of affinities among the players. In addition, we investigate whether the optimal suggestion rule hampers the cultural transmission of trust and trustworthiness. To test this, we consider a pair composed of a parent and a child and allow the parent to exert educational effort for moral development of the child. Transmission of cultural norms is hampered if the parents exert less effort with the suggestion rule, so the question becomes how to motivate parents to exert more effort. Our analysis helps to understand the impact of the suggestion rule on trust and trustworthiness, particularly in the current digital economy where such suggestion rules are prevalent and trust and trustworthiness play a key role to sustain the economics.","PeriodicalId":285784,"journal":{"name":"ERN: Economics of Contract: Theory (Topic)","volume":"2 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2020-06-18","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"129919412","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
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