We analyze an equilibrium choice of a product quality within a supply chain consisting of a manufacturer and a supplier. A quality of an intermediate good is private information of the supplier and determines the quality of a final product. The manufacturer holds all bargaining power and proposes a profit sharing contract to the supplier. We show that (i) such the contract may serve as the efficient mechanism of within-chain coordination in special cases and (ii) tougher market competition may lead to a higher profit of both supplier and manufacturer.
{"title":"Coordination within a Supply Chain with a Profit Sharing Contract","authors":"Igor Sloev, Maria A. Nastych","doi":"10.2139/ssrn.2748286","DOIUrl":"https://doi.org/10.2139/ssrn.2748286","url":null,"abstract":"We analyze an equilibrium choice of a product quality within a supply chain consisting of a manufacturer and a supplier. A quality of an intermediate good is private information of the supplier and determines the quality of a final product. The manufacturer holds all bargaining power and proposes a profit sharing contract to the supplier. We show that (i) such the contract may serve as the efficient mechanism of within-chain coordination in special cases and (ii) tougher market competition may lead to a higher profit of both supplier and manufacturer.","PeriodicalId":285784,"journal":{"name":"ERN: Economics of Contract: Theory (Topic)","volume":"50 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2016-03-21","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"116897355","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 identify covenants in commercial loan contracts that require public borrowers to periodically disclose two types of accounting-related private information to lenders: projected financial statements for future periods and monthly historical financial statements. We hypothesize and provide evidence that: (1) loan contracts include these covenants in settings where they enhance lenders’ loan contract monitoring; (2) the covenants are positively associated with the frequency of loan contract amendments; and (3) lenders trade on the borrower private information they receive in secondary loan markets. We further show that the two types of covenants have predictably different determinants and effects.
{"title":"Borrower Private Information Covenants and Loan Contract Monitoring","authors":"Richard Carrizosa, Stephen G. Ryan","doi":"10.2139/ssrn.2585245","DOIUrl":"https://doi.org/10.2139/ssrn.2585245","url":null,"abstract":"We identify covenants in commercial loan contracts that require public borrowers to periodically disclose two types of accounting-related private information to lenders: projected financial statements for future periods and monthly historical financial statements. We hypothesize and provide evidence that: (1) loan contracts include these covenants in settings where they enhance lenders’ loan contract monitoring; (2) the covenants are positively associated with the frequency of loan contract amendments; and (3) lenders trade on the borrower private information they receive in secondary loan markets. We further show that the two types of covenants have predictably different determinants and effects.","PeriodicalId":285784,"journal":{"name":"ERN: Economics of Contract: Theory (Topic)","volume":"339 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2016-03-02","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"115885346","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 re-examine the seminal persuasion model of Dye (1985), focusing on the contracting power of current shareholders. Current shareholders determine the disclosure policy of a manager, who may be informed about the firm's value. Current shareholders desire higher future stock prices and dislike volatility. We show that the optimal policy is complete non-disclosure. The key intuition is that the disclosure policy cannot affect the expected future stock price, but can affect price volatility, which is minimized under non-disclosure. Our results extend to cheap talk settings and Bayesian persuasion games.
{"title":"Optimal Firm (Non-)Disclosure","authors":"Patrick Hummel, J. Morgan, Phillip C. Stocken","doi":"10.2139/ssrn.2727737","DOIUrl":"https://doi.org/10.2139/ssrn.2727737","url":null,"abstract":"We re-examine the seminal persuasion model of Dye (1985), focusing on the contracting power of current shareholders. Current shareholders determine the disclosure policy of a manager, who may be informed about the firm's value. Current shareholders desire higher future stock prices and dislike volatility. We show that the optimal policy is complete non-disclosure. The key intuition is that the disclosure policy cannot affect the expected future stock price, but can affect price volatility, which is minimized under non-disclosure. Our results extend to cheap talk settings and Bayesian persuasion games.","PeriodicalId":285784,"journal":{"name":"ERN: Economics of Contract: Theory (Topic)","volume":"38 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2016-01-16","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"132732052","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}
A monopolistic information provider sells an informative experiment to a large number of perfectly competitive firms. Within each firm, a principal contracts with an exclusive agent who is privately informed about his production cost. Principals decide whether to acquire the experiment, that is informative about the agent’s production cost. While more accurate information reduces agency costs and allows firms to increase production, it also results in a lower market price, which reduces principals’ willingness to pay for information. We show that, even if information is costless for the provider, the optimal experiment is not fully informative when demand is price-inelastic and agents are likely to be inefficient. This result hinges on the assumption that firms are competitive and exacerbates when principals can coordinate vis-a-vis the information provider. In an imperfectly competitive information market, providers may restrict information by not selling the experiment to some of the principals.
{"title":"Selling Information to Competitive Firms","authors":"Jakub Kastl, Marco Pagnozzi, S. Piccolo","doi":"10.2139/ssrn.2685265","DOIUrl":"https://doi.org/10.2139/ssrn.2685265","url":null,"abstract":"A monopolistic information provider sells an informative experiment to a large number of perfectly competitive firms. Within each firm, a principal contracts with an exclusive agent who is privately informed about his production cost. Principals decide whether to acquire the experiment, that is informative about the agent’s production cost. While more accurate information reduces agency costs and allows firms to increase production, it also results in a lower market price, which reduces principals’ willingness to pay for information. We show that, even if information is costless for the provider, the optimal experiment is not fully informative when demand is price-inelastic and agents are likely to be inefficient. This result hinges on the assumption that firms are competitive and exacerbates when principals can coordinate vis-a-vis the information provider. In an imperfectly competitive information market, providers may restrict information by not selling the experiment to some of the principals.","PeriodicalId":285784,"journal":{"name":"ERN: Economics of Contract: Theory (Topic)","volume":"27 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2015-11-02","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"133540307","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 presents a theory on how firm structure responds to market competitiveness. Firms have often been observed to reallocate control rights, sometimes in response to market competition. We develop a theory on the dependence of firm structure on market competition using an incomplete contract approach. We show that a reallocation of control rights can be an effective way of adapting to changing market competitiveness. We find that when market competitiveness changes, depending on demand elasticity, firms may centralize or decentralize control rights to encourage work incentives or to control risk. We present a few case studies in support of this result. We also investigate the effect of changing demand elasticity and production cost on firm structure, as well as the effect of market competition on efficiency, incentives and risk control after taking into account the endogenous, competition-driven firm structure.
{"title":"Adaptive Firm Structure under Market Competition: Efficiency, Incentives, and Risk Control","authors":"Tiangle Song, Susheng Wang","doi":"10.2139/ssrn.2605298","DOIUrl":"https://doi.org/10.2139/ssrn.2605298","url":null,"abstract":"This paper presents a theory on how firm structure responds to market competitiveness. Firms have often been observed to reallocate control rights, sometimes in response to market competition. We develop a theory on the dependence of firm structure on market competition using an incomplete contract approach. We show that a reallocation of control rights can be an effective way of adapting to changing market competitiveness. We find that when market competitiveness changes, depending on demand elasticity, firms may centralize or decentralize control rights to encourage work incentives or to control risk. We present a few case studies in support of this result. We also investigate the effect of changing demand elasticity and production cost on firm structure, as well as the effect of market competition on efficiency, incentives and risk control after taking into account the endogenous, competition-driven firm structure.","PeriodicalId":285784,"journal":{"name":"ERN: Economics of Contract: Theory (Topic)","volume":"47 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2015-10-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"134061493","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 analyze the effects of publicity and mass media on the contract terms and outcomes in a simple model. Mass media affects contract outcomes because it affects public sentiment regarding the contract, which, in turn, may also affect reputation costs. This interaction of the public with the parties involved in a private contract has been virtually ignored in standard economic theories, simply because the public are outsiders to a private contract. In reality, however, mass media interacts with private contracting in the name of justice, fairness, and sympathy among others. This study incorporates such an interaction into a simple model of moral hazard. In our model, the interaction is reflected in the form of a minimum payment perceived by the public. We find that public sentiment may improve efficiency by utilizing observable but not contractible information. Furthermore, the first-best outcomes are obtainable. While a high minimum payment may achieve a first-best outcome, it may also cause a conflict between the contract parties because the benefit to one party can be a cost to the other party. If the minimum payment is too high, then social welfare may become low, because the principal avoids contracting. Another interesting finding is that contract does not have to be fully implemented. Specifically, the payment under a bad outcome is optimally set below the minimum payment, which means the payment will never be implemented. While not implementable, it still has an incentive effect on the agent. This result shows an interesting twist of the standard economic analysis. Our model provides insight regarding the ex-post conflicts between contract parties that can never be observed if the contract is fully implementable.
{"title":"Publicity","authors":"S. H. Seog","doi":"10.2139/ssrn.2711923","DOIUrl":"https://doi.org/10.2139/ssrn.2711923","url":null,"abstract":"We analyze the effects of publicity and mass media on the contract terms and outcomes in a simple model. Mass media affects contract outcomes because it affects public sentiment regarding the contract, which, in turn, may also affect reputation costs. This interaction of the public with the parties involved in a private contract has been virtually ignored in standard economic theories, simply because the public are outsiders to a private contract. In reality, however, mass media interacts with private contracting in the name of justice, fairness, and sympathy among others. This study incorporates such an interaction into a simple model of moral hazard. In our model, the interaction is reflected in the form of a minimum payment perceived by the public. We find that public sentiment may improve efficiency by utilizing observable but not contractible information. Furthermore, the first-best outcomes are obtainable. While a high minimum payment may achieve a first-best outcome, it may also cause a conflict between the contract parties because the benefit to one party can be a cost to the other party. If the minimum payment is too high, then social welfare may become low, because the principal avoids contracting. Another interesting finding is that contract does not have to be fully implemented. Specifically, the payment under a bad outcome is optimally set below the minimum payment, which means the payment will never be implemented. While not implementable, it still has an incentive effect on the agent. This result shows an interesting twist of the standard economic analysis. Our model provides insight regarding the ex-post conflicts between contract parties that can never be observed if the contract is fully implementable.","PeriodicalId":285784,"journal":{"name":"ERN: Economics of Contract: Theory (Topic)","volume":"4 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2015-10-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"115860892","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}
I study the optimal choice of projects in a continuous‐time moral hazard model with multitasking. I characterize the distortions caused by moral hazard and the dynamics of the firm's project choice. Both overinvestment and underinvestment relative to a net present value (NPV) criterion can occur on the path of the contract. As past performance increases, the firm chooses projects that require higher pay–performance sensitivity. When the continuation value is large, investment projects are chosen more efficiently, and project choice depends more on the NPV and less on the incentive costs.I implement the optimal contract with an equity stake, bonus payments, and a personal account.
{"title":"Incentives, Project Choice, and Dynamic Multitasking","authors":"M. Szydlowski","doi":"10.2139/ssrn.1815408","DOIUrl":"https://doi.org/10.2139/ssrn.1815408","url":null,"abstract":"I study the optimal choice of projects in a continuous‐time moral hazard model with multitasking. I characterize the distortions caused by moral hazard and the dynamics of the firm's project choice. Both overinvestment and underinvestment relative to a net present value (NPV) criterion can occur on the path of the contract. As past performance increases, the firm chooses projects that require higher pay–performance sensitivity. When the continuation value is large, investment projects are chosen more efficiently, and project choice depends more on the NPV and less on the incentive costs.I implement the optimal contract with an equity stake, bonus payments, and a personal account.","PeriodicalId":285784,"journal":{"name":"ERN: Economics of Contract: Theory (Topic)","volume":"16 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2015-05-18","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"122508844","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}
Motivated by tropical deforestation, we analyze (i) a novel theory of resource extraction, (ii) the optimal conservation contract, (iii) when the donor prefers contracting with central rather than local governments, and (iv) how the donor’s presence may induce institutional change. Deforestation can be legal or illegal in the model: each district decides how much to protect and how much to extract for sale on a common market. If districts are strong, in that they find protection inexpensive, extraction is sales-driven and districts bene.t if neighbors conserve. If districts are weak, they lose when neighbors conserve since the smaller supply increases the price and the pressure on the resource, and thus also the cost of protection. Consequently, decentralizing authority increases conservation if and only if districts are weak. Contracting with the central authority is socially optimal, but, on the one hand, the donor benefits from contracting with districts if they are weak; on the other hand, districts prefer to decentralize if they are strong. The presence of the donor may lead to a regime change that increases extraction by more than it is reduced by the contract itself.
{"title":"Conservation Contracts and Political Regimes","authors":"Bård Harstad, Torben K. Mideksa","doi":"10.2139/ssrn.2744535","DOIUrl":"https://doi.org/10.2139/ssrn.2744535","url":null,"abstract":"Motivated by tropical deforestation, we analyze (i) a novel theory of resource extraction, (ii) the optimal conservation contract, (iii) when the donor prefers contracting with central rather than local governments, and (iv) how the donor’s presence may induce institutional change. Deforestation can be legal or illegal in the model: each district decides how much to protect and how much to extract for sale on a common market. If districts are strong, in that they find protection inexpensive, extraction is sales-driven and districts bene.t if neighbors conserve. If districts are weak, they lose when neighbors conserve since the smaller supply increases the price and the pressure on the resource, and thus also the cost of protection. Consequently, decentralizing authority increases conservation if and only if districts are weak. Contracting with the central authority is socially optimal, but, on the one hand, the donor benefits from contracting with districts if they are weak; on the other hand, districts prefer to decentralize if they are strong. The presence of the donor may lead to a regime change that increases extraction by more than it is reduced by the contract itself.","PeriodicalId":285784,"journal":{"name":"ERN: Economics of Contract: Theory (Topic)","volume":"42 ","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2015-04-30","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"120884999","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 analyzes the investment timing for team projects. Under demand uncertainty, it is valuable to maintain flexibility in future investment alternatives. However, one party's flexibility creates strategic uncertainty for another party, which causes the other party to choose a higher level of flexibility. This strategic complementarity leads to delays in investments in contrast to the case of accelerated investments for preemption. This strategic effect is also distinct from the free-rider problem because this study focuses on the second moment of payoffs. The model also provides a rational alternative to the status-quo bias in organizational decision-making.
{"title":"Why Do Team Projects Progress Slowly? A Model Based on Strategic Uncertainty","authors":"Jiro Yoshida","doi":"10.2139/ssrn.2204106","DOIUrl":"https://doi.org/10.2139/ssrn.2204106","url":null,"abstract":"This paper analyzes the investment timing for team projects. Under demand uncertainty, it is valuable to maintain flexibility in future investment alternatives. However, one party's flexibility creates strategic uncertainty for another party, which causes the other party to choose a higher level of flexibility. This strategic complementarity leads to delays in investments in contrast to the case of accelerated investments for preemption. This strategic effect is also distinct from the free-rider problem because this study focuses on the second moment of payoffs. The model also provides a rational alternative to the status-quo bias in organizational decision-making.","PeriodicalId":285784,"journal":{"name":"ERN: Economics of Contract: Theory (Topic)","volume":"47 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2015-02-16","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"116820096","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 investigates the optimal contract between a principal and an agent that manages a business group and diverts funds among its projects. The optimal contract can be implemented by limited liability financial securities and results in a capital structure that provides risk sharing among the group firms. The paper provides explanations for the cross-holding of equity between firms in business groups, the contagion between the asset prices of such firms, and shows that a tax on intercorporate dividends may render the organization of such groups infeasible and lead to the creation of conglomerates.
{"title":"Security Design and Capital Structure of Business Groups","authors":"Alexandre Messa","doi":"10.2139/ssrn.2632136","DOIUrl":"https://doi.org/10.2139/ssrn.2632136","url":null,"abstract":"This paper investigates the optimal contract between a principal and an agent that manages a business group and diverts funds among its projects. The optimal contract can be implemented by limited liability financial securities and results in a capital structure that provides risk sharing among the group firms. The paper provides explanations for the cross-holding of equity between firms in business groups, the contagion between the asset prices of such firms, and shows that a tax on intercorporate dividends may render the organization of such groups infeasible and lead to the creation of conglomerates.","PeriodicalId":285784,"journal":{"name":"ERN: Economics of Contract: Theory (Topic)","volume":"1 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2015-01-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"116149136","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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