Curtis R. Taylor, Giuseppe Lopomo, Vijaykrishna Venkataraman
A principal contracts optimally with an agent to operate a firm over an infinite time horizon when the agent is liquidity constrained and has access to private information about the sequence of cost realizations. We formulate this mechanism design problem as a recursive dynamic program in which promised utility to the agent is the relevant state variable. By establishing that output distortions and the stringency of liquidity constraints decrease monotonically in promised utility, we are able to interpret the state variable as the agent’s equity in the firm. We establish a bang-bang property of optimal contracts wherein the agent is incentivised only through adjustments to his future utility until achieving a critical level of equity, after which he may be incentivised through cash payments, that is, through instantaneous rents. Thus the incentive scheme resembles what is commonly regarded as a sweat equity contract, with all cash payments net of costs (rents) being back loaded. A critical level of sweat equity occurs when none of the agent’s liquidity constraints bind. At this point, the contract calls for efficient production in all future periods and the agent attains a vested ownership stake in the firm. Finally, properties of the theoretically optimal contract are shown to be similar to features common in real-world work-to-own franchising agreements and venture capital contracts.
{"title":"Stairway to Heaven or Highway to Hell: Liquidity, Sweat Equity, and the Uncertain Path to Ownership","authors":"Curtis R. Taylor, Giuseppe Lopomo, Vijaykrishna Venkataraman","doi":"10.2139/ssrn.1685322","DOIUrl":"https://doi.org/10.2139/ssrn.1685322","url":null,"abstract":"A principal contracts optimally with an agent to operate a firm over an infinite time horizon when the agent is liquidity constrained and has access to private information about the sequence of cost realizations. We formulate this mechanism design problem as a recursive dynamic program in which promised utility to the agent is the relevant state variable. By establishing that output distortions and the stringency of liquidity constraints decrease monotonically in promised utility, we are able to interpret the state variable as the agent’s equity in the firm. We establish a bang-bang property of optimal contracts wherein the agent is incentivised only through adjustments to his future utility until achieving a critical level of equity, after which he may be incentivised through cash payments, that is, through instantaneous rents. Thus the incentive scheme resembles what is commonly regarded as a sweat equity contract, with all cash payments net of costs (rents) being back loaded. A critical level of sweat equity occurs when none of the agent’s liquidity constraints bind. At this point, the contract calls for efficient production in all future periods and the agent attains a vested ownership stake in the firm. Finally, properties of the theoretically optimal contract are shown to be similar to features common in real-world work-to-own franchising agreements and venture capital contracts.","PeriodicalId":285784,"journal":{"name":"ERN: Economics of Contract: Theory (Topic)","volume":"31 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2010-09-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"128471918","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}
Using a newly introduced TRACE variable that identifies the side(s) taken by dealers in each trade, I find that 37 percent of dealer-client trades are accompanied by an inter-dealer trade, usually for the exact same quantity and often executed at the exact second as the client trade. All but 0.4 percent of these trade pairs would involve a non-negative profit for a dealer who was involved in both trades. Pairing is much more common for small trades - 46 percent of trades under $100,000 are paired, but only 4.5 percent of trades of $500,000 and above. Controlling for trade size, pairing is less common for trades by institutional clients. Paired trades involve higher trading costs, which are split roughly 50-50 between the pairing dealer and the dealer ultimately taking the other side. Taken together, the evidence suggests that pairing is a symptom of clients being unable to search over the entire market, producing nearly risk-free trading profits for dealers with client relationships or contractual rights to handle order flow.
{"title":"Paired Corporate Bond Trades","authors":"Eric Zitzewitz","doi":"10.2139/ssrn.1648994","DOIUrl":"https://doi.org/10.2139/ssrn.1648994","url":null,"abstract":"Using a newly introduced TRACE variable that identifies the side(s) taken by dealers in each trade, I find that 37 percent of dealer-client trades are accompanied by an inter-dealer trade, usually for the exact same quantity and often executed at the exact second as the client trade. All but 0.4 percent of these trade pairs would involve a non-negative profit for a dealer who was involved in both trades. Pairing is much more common for small trades - 46 percent of trades under $100,000 are paired, but only 4.5 percent of trades of $500,000 and above. Controlling for trade size, pairing is less common for trades by institutional clients. Paired trades involve higher trading costs, which are split roughly 50-50 between the pairing dealer and the dealer ultimately taking the other side. Taken together, the evidence suggests that pairing is a symptom of clients being unable to search over the entire market, producing nearly risk-free trading profits for dealers with client relationships or contractual rights to handle order flow.","PeriodicalId":285784,"journal":{"name":"ERN: Economics of Contract: Theory (Topic)","volume":"113 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2010-07-26","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"132858481","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}
Florian Englmaier, Gerd Muehlheusser, Andreas Roider
We characterize optimal incentive contracts in a moral hazard framework extended in two directions. First, after effort provision, the agent is free to leave and pursue some ex-post outside option. Second, the value of this outside option is increasing in effort, and hence endogenous. Optimal contracts may entail properties such as inducing first-best effort and surplus, or non-responsiveness with respect to changes in verifiable parameters. Moreover, while always socially inefficient, separation might occur in equilibrium. Except for the latter, these findings are robust to renegotiation. When the outside option is exogenous instead, the standard results obtain.
{"title":"Optimal Incentive Contracts Under Moral Hazard When the Agent is Free to Leave","authors":"Florian Englmaier, Gerd Muehlheusser, Andreas Roider","doi":"10.2139/SSRN.1986264","DOIUrl":"https://doi.org/10.2139/SSRN.1986264","url":null,"abstract":"We characterize optimal incentive contracts in a moral hazard framework extended in two directions. First, after effort provision, the agent is free to leave and pursue some ex-post outside option. Second, the value of this outside option is increasing in effort, and hence endogenous. Optimal contracts may entail properties such as inducing first-best effort and surplus, or non-responsiveness with respect to changes in verifiable parameters. Moreover, while always socially inefficient, separation might occur in equilibrium. Except for the latter, these findings are robust to renegotiation. When the outside option is exogenous instead, the standard results obtain.","PeriodicalId":285784,"journal":{"name":"ERN: Economics of Contract: Theory (Topic)","volume":"27 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2010-07-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"121800079","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 study the effects of exclusive contracts and market-share discounts (i.e., discounts conditioned on the share a firm receives of the customer's total purchases) in an adverse selection model where firms supply differentiated products and compete in non-linear prices. We show that exclusive contracts intensify the competition among the firms, increasing consumer surplus, improving efficiency, and reducing profits. Firms would gain if these contracts were prohibited, but are caught in a prisoner's dilemma if they are permitted. In this latter case, allowing firms to offer also market-share discounts unambiguously weakens competition, reducing efficiency and harming consumers. However, starting from a situation where exclusive contracts are prohibited, the effect of market-share discounts (which include exclusive contracts as a limiting case) is ambiguous.
{"title":"Competition with Exclusive Contracts and Market-Share Discounts","authors":"G. Calzolari, V. Denicoló","doi":"10.2139/ssrn.1522195","DOIUrl":"https://doi.org/10.2139/ssrn.1522195","url":null,"abstract":"We study the effects of exclusive contracts and market-share discounts (i.e., discounts conditioned on the share a firm receives of the customer's total purchases) in an adverse selection model where firms supply differentiated products and compete in non-linear prices. We show that exclusive contracts intensify the competition among the firms, increasing consumer surplus, improving efficiency, and reducing profits. Firms would gain if these contracts were prohibited, but are caught in a prisoner's dilemma if they are permitted. In this latter case, allowing firms to offer also market-share discounts unambiguously weakens competition, reducing efficiency and harming consumers. However, starting from a situation where exclusive contracts are prohibited, the effect of market-share discounts (which include exclusive contracts as a limiting case) is ambiguous.","PeriodicalId":285784,"journal":{"name":"ERN: Economics of Contract: Theory (Topic)","volume":"22 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2009-12-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"127926789","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}
Pub Date : 2009-09-01DOI: 10.1111/j.1539-6975.2009.01317.x
Silke Finken, C. Laux
We identify a new benefit of index or parametric triggers. Asymmetric information between reinsurers on an insurer's risk affects competition in the reinsurance market: reinsurers are subject to adverse selection, since only high-risk insurers may find it optimal to change reinsurers. The result is high reinsurance premiums and cross-subsidization of high-risk insurers by low-risk insurers. A contract with a parametric or index trigger (such as a catastrophe bond) is insensitive to information asymmetry and therefore alters the equilibrium in the reinsurance market. Provided that basis risk is not too high, the introduction of contracts with parametric or index triggers provides low-risk insurers with an alternative to reinsurance contracts, and therefore leads to less cross-subsidization in the reinsurance market.
{"title":"Catastrophe Bonds and Reinsurance: The Competitive Effect of Information-Insensitive Triggers","authors":"Silke Finken, C. Laux","doi":"10.1111/j.1539-6975.2009.01317.x","DOIUrl":"https://doi.org/10.1111/j.1539-6975.2009.01317.x","url":null,"abstract":"We identify a new benefit of index or parametric triggers. Asymmetric information between reinsurers on an insurer's risk affects competition in the reinsurance market: reinsurers are subject to adverse selection, since only high-risk insurers may find it optimal to change reinsurers. The result is high reinsurance premiums and cross-subsidization of high-risk insurers by low-risk insurers. A contract with a parametric or index trigger (such as a catastrophe bond) is insensitive to information asymmetry and therefore alters the equilibrium in the reinsurance market. Provided that basis risk is not too high, the introduction of contracts with parametric or index triggers provides low-risk insurers with an alternative to reinsurance contracts, and therefore leads to less cross-subsidization in the reinsurance market.","PeriodicalId":285784,"journal":{"name":"ERN: Economics of Contract: Theory (Topic)","volume":"14 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2009-09-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"117013464","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 study voluntary defined-contribution pension contracts with the incentive problem of early retirement and low contributions over time. Agents are free to retire, quit a plan and choose between plans. The fluctuation of labor productivity throughout working life and the length of working life are private information. The optimal contract can be implemented through transfers (sometimes negative) and contribution deductions from agents' pensions over time. The optimal contract features a punishment phase, an accumulation phase and a retirement phase. We find that the amount of pension is higher under the optimal contract than under laissez faire. Working agents enjoy higher consumption, contribute less, and retire later. The result is robust to different environments.
{"title":"Dynamic Defined-Contribution Pension Design with Adverse Selection and Moral Hazard","authors":"Tsz-Nga Wong","doi":"10.2139/ssrn.1954235","DOIUrl":"https://doi.org/10.2139/ssrn.1954235","url":null,"abstract":"We study voluntary defined-contribution pension contracts with the incentive problem of early retirement and low contributions over time. Agents are free to retire, quit a plan and choose between plans. The fluctuation of labor productivity throughout working life and the length of working life are private information. The optimal contract can be implemented through transfers (sometimes negative) and contribution deductions from agents' pensions over time. The optimal contract features a punishment phase, an accumulation phase and a retirement phase. We find that the amount of pension is higher under the optimal contract than under laissez faire. Working agents enjoy higher consumption, contribute less, and retire later. The result is robust to different environments.","PeriodicalId":285784,"journal":{"name":"ERN: Economics of Contract: Theory (Topic)","volume":"88 34 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2009-03-30","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"121352048","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}
Pub Date : 2009-02-16DOI: 10.5040/9781472560223.ch-020
Stephen Smith
This paper argues that to understand court orders (e.g., injunctions, specific performance, orders to pay damages, etc.) it is necessary to distinguish clearly between their content and their existence. The reasons that justify the content of a court order are different from the reasons that justify making an order at all. In terms of their content, many court orders merely confirm duties that arise from non-wrongs, such as the non-wrong of making a contract or receiving a mistaken payment. The duties recognized in such orders (e.g., to pay a contractual debt, to return a mistaken payment) are not duties to remedy wrongs; they are duties not to commit wrongs. In this respect, Peter Birks was correct to query the practice of describing court orders as remedies. But in terms of the reasons for making court orders, an examination of the most important categories of orders shows that they are not made except on proof of an actual or imminent wrong. In this respect, it is correct to say, with Blackstone (and against Birks), that court orders are remedial, even when the duties they enforce arise from a non-wrong. The general theme of the essay, therefore, is the importance of understanding both why courts order defendants to do or not do particular things and (what is a different issue) why courts agree to make orders at all.
{"title":"Rights, Remedies, and Causes of Action","authors":"Stephen Smith","doi":"10.5040/9781472560223.ch-020","DOIUrl":"https://doi.org/10.5040/9781472560223.ch-020","url":null,"abstract":"This paper argues that to understand court orders (e.g., injunctions, specific performance, orders to pay damages, etc.) it is necessary to distinguish clearly between their content and their existence. The reasons that justify the content of a court order are different from the reasons that justify making an order at all. In terms of their content, many court orders merely confirm duties that arise from non-wrongs, such as the non-wrong of making a contract or receiving a mistaken payment. The duties recognized in such orders (e.g., to pay a contractual debt, to return a mistaken payment) are not duties to remedy wrongs; they are duties not to commit wrongs. In this respect, Peter Birks was correct to query the practice of describing court orders as remedies. But in terms of the reasons for making court orders, an examination of the most important categories of orders shows that they are not made except on proof of an actual or imminent wrong. In this respect, it is correct to say, with Blackstone (and against Birks), that court orders are remedial, even when the duties they enforce arise from a non-wrong. The general theme of the essay, therefore, is the importance of understanding both why courts order defendants to do or not do particular things and (what is a different issue) why courts agree to make orders at all.","PeriodicalId":285784,"journal":{"name":"ERN: Economics of Contract: Theory (Topic)","volume":"189 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2009-02-16","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"115606463","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 empirically analyses the hypothesis of the existence of a dual market for contracts in local services. Large firms that operate on a national basis control the contracts for delivery in the most populated and/or urban municipalities, whereas small firms that operate at a local level have the contracts in the least populated and/or rural municipalities. The dual market implies the high concentration and dominance of major firms in large municipalities, and local monopolies in the smaller ones. This market structure is harmful to competition for the market as the effective number of competitors is low across all municipalities. Thus, it damages the likelihood of obtaining cost savings from privatization.
{"title":"Privatization and Competition in the Delivery of Local Services: An Empirical Examination of the Dual Market Hypothesis","authors":"G. Bel, Xavier Fageda","doi":"10.2139/ssrn.1843146","DOIUrl":"https://doi.org/10.2139/ssrn.1843146","url":null,"abstract":"This paper empirically analyses the hypothesis of the existence of a dual market for contracts in local services. Large firms that operate on a national basis control the contracts for delivery in the most populated and/or urban municipalities, whereas small firms that operate at a local level have the contracts in the least populated and/or rural municipalities. The dual market implies the high concentration and dominance of major firms in large municipalities, and local monopolies in the smaller ones. This market structure is harmful to competition for the market as the effective number of competitors is low across all municipalities. Thus, it damages the likelihood of obtaining cost savings from privatization.","PeriodicalId":285784,"journal":{"name":"ERN: Economics of Contract: Theory (Topic)","volume":"57 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2008-04-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"129641283","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 seeks to extend the standard assumption concerning incomplete contracts (New Institutional Economics). It is based on a very specific market transaction, within which parties can not affect the market structure. Instead, referring to transaction as introduced by John R. Commons, we want to stress in an incomplete contract the impact of competition dynamics on parties "bargaining power and parties" incentives to influence market competition in order to enhance their bargaining power. This view leads to broader and (sometimes divergent) results with respect to standard literature on incomplete contract.
本文试图扩展关于不完全契约的标准假设(新制度经济学)。它是基于一个非常具体的市场交易，其中各方不能影响市场结构。相反，参考John R. Commons引入的交易，我们希望在不完全合同中强调竞争动态对各方“议价能力”的影响，以及各方为了提高议价能力而影响市场竞争的动机。这种观点导致了关于不完全契约的标准文献的更广泛和(有时是不同的)结果。
{"title":"The Contract and the Market: Towards a Broader Notion of Transaction?","authors":"A. Nicita, Massimiliano Vatiero","doi":"10.2139/ssrn.2473437","DOIUrl":"https://doi.org/10.2139/ssrn.2473437","url":null,"abstract":"This paper seeks to extend the standard assumption concerning incomplete contracts (New Institutional Economics). It is based on a very specific market transaction, within which parties can not affect the market structure. Instead, referring to transaction as introduced by John R. Commons, we want to stress in an incomplete contract the impact of competition dynamics on parties \"bargaining power and parties\" incentives to influence market competition in order to enhance their bargaining power. This view leads to broader and (sometimes divergent) results with respect to standard literature on incomplete contract.","PeriodicalId":285784,"journal":{"name":"ERN: Economics of Contract: Theory (Topic)","volume":"120 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2007-07-29","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"116355546","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}
It has become increasingly popular in practice to implement incentive systems that create goal-congruent investment behaviour between central and divisional management. In the following paper, it is shown that only linear contracts enable goal-congruent investment decisions if central management does not have information about the investment project. This might cast a new light on why linear compensation schemes are often used in practice.
{"title":"On the Optimality of Linear Contracts to Induce Goal-Congruent Investment Behavior","authors":"L. Velthuis, T. Pfeiffer","doi":"10.2139/ssrn.1027075","DOIUrl":"https://doi.org/10.2139/ssrn.1027075","url":null,"abstract":"It has become increasingly popular in practice to implement incentive systems that create goal-congruent investment behaviour between central and divisional management. In the following paper, it is shown that only linear contracts enable goal-congruent investment decisions if central management does not have information about the investment project. This might cast a new light on why linear compensation schemes are often used in practice.","PeriodicalId":285784,"journal":{"name":"ERN: Economics of Contract: Theory (Topic)","volume":"9 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2004-07-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"123475413","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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