This paper examines the law and economics of third-party financed litigation. I explore the conditions under which a system of third-party financiers and litigators can enhance social welfare, and the conditions under which it is likely to reduce social welfare. Among the applications I consider are the sale of legal rights (such as contingent tort claims) to insurers, to patent trolls, and to financiers generally.
{"title":"The Economics of Third-Party Financed Litigation","authors":"Keith N. Hylton","doi":"10.2139/ssrn.1971229","DOIUrl":"https://doi.org/10.2139/ssrn.1971229","url":null,"abstract":"This paper examines the law and economics of third-party financed litigation. I explore the conditions under which a system of third-party financiers and litigators can enhance social welfare, and the conditions under which it is likely to reduce social welfare. Among the applications I consider are the sale of legal rights (such as contingent tort claims) to insurers, to patent trolls, and to financiers generally.","PeriodicalId":285784,"journal":{"name":"ERN: Economics of Contract: Theory (Topic)","volume":"156 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2011-12-12","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"125777250","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 a two-period agency problem with limited liability and nonverifiable information. The principal commits to a dynamic bonus pool comprising a fixed total payment that may be distributed over time to the agent and a third party. We find that the optimal two-period contract features memory. If the agent succeeds in the first-period, second-period incentives are weakened whereas higher-powered incentives are provided if he fails. The two-period bonus pool offers a complementary reason for why third-party payments are not commonly observed in practice.
{"title":"Dynamic Bonus Pools","authors":"Jörg Budde, C. Hofmann","doi":"10.2139/ssrn.1899204","DOIUrl":"https://doi.org/10.2139/ssrn.1899204","url":null,"abstract":"We analyze a two-period agency problem with limited liability and nonverifiable information. The principal commits to a dynamic bonus pool comprising a fixed total payment that may be distributed over time to the agent and a third party. We find that the optimal two-period contract features memory. If the agent succeeds in the first-period, second-period incentives are weakened whereas higher-powered incentives are provided if he fails. The two-period bonus pool offers a complementary reason for why third-party payments are not commonly observed in practice.","PeriodicalId":285784,"journal":{"name":"ERN: Economics of Contract: Theory (Topic)","volume":"58 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2011-11-23","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"116677279","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 revisit the role of limited commitment in a dynamic risk-sharing setting with private information. We show that a Markov-perfect equilibrium, in which agent and insurer cannot commit beyond the current period, and an infinitely-long contract to which only the insurer can commit, implement identical consumption, effort and welfare outcomes. Unlike contracts with full commitment by the insurer, Markov-perfect contracts feature non-trivial and determinate asset dynamics. Numerically, we show that Markov-perfect contracts provide sizable insurance, especially at low asset levels, and are able to explain a significant part of wealth inequality beyond what can be explained by self-insurance. The welfare gains from resolving the commitment friction are larger than those from resolving the moral hazard problem at low asset levels, while the opposite holds for high asset levels.
{"title":"Moral Hazard and Lack of Commitment in Dynamic Economies","authors":"A. Karaivanov, F. Martin","doi":"10.2139/ssrn.2038950","DOIUrl":"https://doi.org/10.2139/ssrn.2038950","url":null,"abstract":"We revisit the role of limited commitment in a dynamic risk-sharing setting with private information. We show that a Markov-perfect equilibrium, in which agent and insurer cannot commit beyond the current period, and an infinitely-long contract to which only the insurer can commit, implement identical consumption, effort and welfare outcomes. Unlike contracts with full commitment by the insurer, Markov-perfect contracts feature non-trivial and determinate asset dynamics. Numerically, we show that Markov-perfect contracts provide sizable insurance, especially at low asset levels, and are able to explain a significant part of wealth inequality beyond what can be explained by self-insurance. The welfare gains from resolving the commitment friction are larger than those from resolving the moral hazard problem at low asset levels, while the opposite holds for high asset levels.","PeriodicalId":285784,"journal":{"name":"ERN: Economics of Contract: Theory (Topic)","volume":"87 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2011-10-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"124908434","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}
Linear contracts are popular in delegated portfolio management. This paper studies the incentive of linear performance-adjusted contracts in delegated portfolio management under a VaR constraint with a principal-agent model and numerical analysis. It is shown that a linear performance-based contract provides incentives to a portfolio manager to work at acquiring private information under a total risk constraint. The expected utility and optimal effort are increasing functions of the return sharing ratio for a risk-averse manager. However, a risk constraint makes a portfolio manager to reduce effort in gathering private information, suggesting that the VaR constraint increases the moral hazard between the investor and the manager.
{"title":"Incentive Contract in Delegated Portfolio Management Under VaR Constraint","authors":"Jiliang Sheng, Jun Yang","doi":"10.2139/ssrn.1925785","DOIUrl":"https://doi.org/10.2139/ssrn.1925785","url":null,"abstract":"Linear contracts are popular in delegated portfolio management. This paper studies the incentive of linear performance-adjusted contracts in delegated portfolio management under a VaR constraint with a principal-agent model and numerical analysis. It is shown that a linear performance-based contract provides incentives to a portfolio manager to work at acquiring private information under a total risk constraint. The expected utility and optimal effort are increasing functions of the return sharing ratio for a risk-averse manager. However, a risk constraint makes a portfolio manager to reduce effort in gathering private information, suggesting that the VaR constraint increases the moral hazard between the investor and the manager.","PeriodicalId":285784,"journal":{"name":"ERN: Economics of Contract: Theory (Topic)","volume":"77 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2011-09-10","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"127202097","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 investigate the design of optimal share-based incentive contracts by formulating a stochastic differential game between a listed company and a representative manager. The value maximizing company can grant share-based payments to the manager as incentive component of the total salary package at a premium. The manager is assumed to maximize utility from investment and consumption net of the cost for work effort. The information asymmetry is built into the model by allowing the manager to observe the level of share-based payments granted by the company. The effort exercised by the manager and her investment and consumption decision cannot be observed by the company. Accordingly we obtain a stochastic differential game of Stackelberg type. For this setting we identify a Stackelberg equilibrium that is subgame perfect Nash equilibrium by construction. Based on the equilibrium strategies we derive the optimal contract design. The results are discussed emphasizing the effect of company characteristics such as volatility and size, and manager characteristics, such as work productivity.
{"title":"Optimal Share-Based Payments","authors":"Alexander Szimayer","doi":"10.2139/ssrn.1916307","DOIUrl":"https://doi.org/10.2139/ssrn.1916307","url":null,"abstract":"We investigate the design of optimal share-based incentive contracts by formulating a stochastic differential game between a listed company and a representative manager. The value maximizing company can grant share-based payments to the manager as incentive component of the total salary package at a premium. The manager is assumed to maximize utility from investment and consumption net of the cost for work effort. The information asymmetry is built into the model by allowing the manager to observe the level of share-based payments granted by the company. The effort exercised by the manager and her investment and consumption decision cannot be observed by the company. Accordingly we obtain a stochastic differential game of Stackelberg type. For this setting we identify a Stackelberg equilibrium that is subgame perfect Nash equilibrium by construction. Based on the equilibrium strategies we derive the optimal contract design. The results are discussed emphasizing the effect of company characteristics such as volatility and size, and manager characteristics, such as work productivity.","PeriodicalId":285784,"journal":{"name":"ERN: Economics of Contract: Theory (Topic)","volume":"85 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2011-08-24","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"127892336","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 study examines how earnings predictability affects bank loan contracting. Using a sample of 8,626 bank loan contracts, we find that firms with more predictable earnings have more favorable loan terms, such as lower interest rates, longer maturities, and fewer covenants and collateral requirements. These results are robust to alternative specifications and earnings predictability measures. Additional analyses indicate that the relation between earnings predictability and bank loan cost varies with the availability of private information about borrowers, lenders’ monitoring incentives, the competition between banks and bond investors, and firm size. Overall, this study demonstrates that earnings predictability is an important determinant in the design of bank lending contracts affecting both price and nonprice loan terms.
{"title":"The Impact of Earnings Predictability on Bank Loan Contracting","authors":"I. Hasan, Jong Chool Park, Qiang Wu","doi":"10.2139/ssrn.1898197","DOIUrl":"https://doi.org/10.2139/ssrn.1898197","url":null,"abstract":"This study examines how earnings predictability affects bank loan contracting. Using a sample of 8,626 bank loan contracts, we find that firms with more predictable earnings have more favorable loan terms, such as lower interest rates, longer maturities, and fewer covenants and collateral requirements. These results are robust to alternative specifications and earnings predictability measures. Additional analyses indicate that the relation between earnings predictability and bank loan cost varies with the availability of private information about borrowers, lenders’ monitoring incentives, the competition between banks and bond investors, and firm size. Overall, this study demonstrates that earnings predictability is an important determinant in the design of bank lending contracts affecting both price and nonprice loan terms.","PeriodicalId":285784,"journal":{"name":"ERN: Economics of Contract: Theory (Topic)","volume":"69 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2011-07-28","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"130419728","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 strategic use of bilateral supply contracts in sequential negotiations between one manufacturer and two differentiated retailers. Allowing for general contracts and retail bargaining power, I show that the first contracting parties have incentives to manipulate their contract to shift rent from the second contracting retailer and these incentives distort the industry profit away from the fully integrated monopoly outcome. To avoid such distortion, the first contracting parties may prefer to sign a contract which has no commitment power and can be renegotiated from scratch should the manufacturer fail in its subsequent negotiation with the second retailer. Renegotiation from scratch induces the first contracting parties to implement the monopoly prices and might enable them to capture the maximized industry profit. A slotting fee, an up-front fee paid by the manufacturer to the first retailer, and a menu of tariff-quantity pairs are sufficient contracts to implement the monopoly outcome. These results do not depend on the type of retail competition, the level of differentiation between the retailers, the order of sequential negotiations, the level of asymmetry between the retailers in terms of their bargaining power vis-a-vis the manufacturer or their profitability in exclusive dealing.
{"title":"Vertical Coordination Through Renegotiation","authors":"Özlem Bedre-Defolie","doi":"10.2139/ssrn.1894584","DOIUrl":"https://doi.org/10.2139/ssrn.1894584","url":null,"abstract":"This paper analyzes the strategic use of bilateral supply contracts in sequential negotiations between one manufacturer and two differentiated retailers. Allowing for general contracts and retail bargaining power, I show that the first contracting parties have incentives to manipulate their contract to shift rent from the second contracting retailer and these incentives distort the industry profit away from the fully integrated monopoly outcome. To avoid such distortion, the first contracting parties may prefer to sign a contract which has no commitment power and can be renegotiated from scratch should the manufacturer fail in its subsequent negotiation with the second retailer. Renegotiation from scratch induces the first contracting parties to implement the monopoly prices and might enable them to capture the maximized industry profit. A slotting fee, an up-front fee paid by the manufacturer to the first retailer, and a menu of tariff-quantity pairs are sufficient contracts to implement the monopoly outcome. These results do not depend on the type of retail competition, the level of differentiation between the retailers, the order of sequential negotiations, the level of asymmetry between the retailers in terms of their bargaining power vis-a-vis the manufacturer or their profitability in exclusive dealing.","PeriodicalId":285784,"journal":{"name":"ERN: Economics of Contract: Theory (Topic)","volume":"99 2 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2011-07-25","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"124326498","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 examines conditions under which the agency problem in PPP (expropriation of the private partner by the state) could be rectified. We propose that the issue lies not in a 'complete contract' (a more protective ex ante contract) in mitigating the agency problem in PPP, but rather the opposite! A least protective contract (no contract at all), coupled with the dynamics of an optimal 'investment destruction' retaliatory strategy profile can solve the agency problem. We employ Selten’s idea of 'trembles' in decision making process, that is, in real world PPP decisions are often 'blurred' by bounded rationality and other inconsistencies. These results provide a credible pre-commitment on the part of the state against expropriation in the future and a strategic rationale for PPP in which tacit collusion will always be sustained.
{"title":"Revisiting Agency Problems in Public Private Partnerships","authors":"Bo Jiang, Anthony T.H. Chin","doi":"10.2139/ssrn.1961486","DOIUrl":"https://doi.org/10.2139/ssrn.1961486","url":null,"abstract":"This paper examines conditions under which the agency problem in PPP (expropriation of the private partner by the state) could be rectified. We propose that the issue lies not in a 'complete contract' (a more protective ex ante contract) in mitigating the agency problem in PPP, but rather the opposite! A least protective contract (no contract at all), coupled with the dynamics of an optimal 'investment destruction' retaliatory strategy profile can solve the agency problem. We employ Selten’s idea of 'trembles' in decision making process, that is, in real world PPP decisions are often 'blurred' by bounded rationality and other inconsistencies. These results provide a credible pre-commitment on the part of the state against expropriation in the future and a strategic rationale for PPP in which tacit collusion will always be sustained.","PeriodicalId":285784,"journal":{"name":"ERN: Economics of Contract: Theory (Topic)","volume":"39 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2011-06-18","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"132526423","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 a dynamic agency problem which includes limited liability, moral hazard, and adverse selection. The paper develops a robust approach to dynamic contracting based on calibrating the incentive properties of simple benchmark contracts that are attractive but infeasible, due to limited liability constraints. The resulting dynamic contracts are detail-free and satisfy robust performance bounds independently of the underlying process for returns, which need not be i.i.d. or even ergodic. [PUBLICATION ABSTRACT]
{"title":"Calibrated Incentive Contracts","authors":"Sylvain Chassang","doi":"10.2139/ssrn.1836482","DOIUrl":"https://doi.org/10.2139/ssrn.1836482","url":null,"abstract":"This paper studies a dynamic agency problem which includes limited liability, moral hazard, and adverse selection. The paper develops a robust approach to dynamic contracting based on calibrating the incentive properties of simple benchmark contracts that are attractive but infeasible, due to limited liability constraints. The resulting dynamic contracts are detail-free and satisfy robust performance bounds independently of the underlying process for returns, which need not be i.i.d. or even ergodic. [PUBLICATION ABSTRACT]","PeriodicalId":285784,"journal":{"name":"ERN: Economics of Contract: Theory (Topic)","volume":"1 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2011-04-24","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"129105567","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 noncontractible investments in a model with shading. A seller can make an investment that affects a buyer’s value. The parties have outside options that depend on asset ownership. When shading is not possible and there is no contract renegotiation, an optimum can be achieved by giving the seller the right to make a take-it-or-leave-it offer. However, with shading, such a contract creates deadweight losses. We show that an optimal contract will limit the seller’s offers, and possibly create ex post inefficiency. Asset ownership can improve matters even if revelation mechanisms are allowed.
{"title":"Noncontractible Investments and Reference Points","authors":"O. Hart","doi":"10.3390/g4030437","DOIUrl":"https://doi.org/10.3390/g4030437","url":null,"abstract":"We analyze noncontractible investments in a model with shading. A seller can make an investment that affects a buyer’s value. The parties have outside options that depend on asset ownership. When shading is not possible and there is no contract renegotiation, an optimum can be achieved by giving the seller the right to make a take-it-or-leave-it offer. However, with shading, such a contract creates deadweight losses. We show that an optimal contract will limit the seller’s offers, and possibly create ex post inefficiency. Asset ownership can improve matters even if revelation mechanisms are allowed.","PeriodicalId":285784,"journal":{"name":"ERN: Economics of Contract: Theory (Topic)","volume":"28 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2011-04-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"116435518","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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