Electoral cycles in savings bank lending

Abstract:

We provide evidence that German savings banks – where local politicians are by law involved in their management – systematically adjust lending policies in response to local electoral cycles. The different timing of county elections across states and the existence of a control group of cooperative banks – that are very similar to savings banks but lack their political connectedness – allow for clean identification of causal effects of county elections on savings banks’ lending. These effects are economically meaningful and robust to various specifications. Moreover, politically induced lending increases in incumbent party entrenchment and in the contestedness of upcoming elections.

Keywords: Bank lending cycles, political business cycles, political connectedness, public banks, government ownership of firms

JEL classification: G21, D72, D73

Full text in pdf format:

508.pdf

The Role of Communication of Performance Schemes: Evidence from a Field Experiment

Abstract:

In corporate practice, incentive schemes are often complicated even for simple tasks. Hence, the way they are communicated might matter. In a controlled field experiment, we study a minimally invasive change in the communication of a well-established incentive scheme - a reminder regarding the piece rate at the beginning of the shift. The experiment was conducted in a large firm where experienced managers work in a team production setting and where incentives for both quantity and quality of output are provided. While the treatment conveyed no additional material information and left the incentive system unchanged, it had significant positive effects on quantity and on managers' compensation. These effects are economically sizable and robust to alternative empirical specifications. We consider various potential mechanisms, where our preferred explanation - improved salience of incentives - is consistent with all of the findings.

Keywords: incentives, attention, salience, communication, field experiment

JEL classification: M52, J30, D03, D80

Full text in pdf format:

507.pdf

Size Matters - “Over”investments in a Relational Contracting Setting

Abstract:

The corporate finance literature documents that managers tend to overinvest into physical assets. A number of theoretical contributions have aimed to explain this stylized fact, most of them focussing on a fundamental agency problem between shareholders and managers. The present paper shows that overinvestments are not necessarily the (negative) consequence of agency problems between shareholders and managers, but instead might be a second-best optimal response if the scope of court-enforceable contracts is limited. In such an environment a firm has to rely on relational contracts in order to manage the agency relationship with its workforce. The paper shows that investments into physical productive assets enhance the enforceability of relational contracts and hence investments optimally are “too high”.

JEL Codes: C73, D21, D86, G32

Keywords: relational contracts, corporate finance, capital investments

Full text in pdf format:

506.pdf

Price discontinuities in an online market for used cars

Abstract:

We use more than 63,000 datapoints from a German used car market website to document systematic and substantial price drops at vintage (= year of first registration) thresholds and 10,000 km odometer marks. The latter finding replicates the findings in Lacetera et al. (2012), whereas the first dimension cannot be analyzed with their US data because only German cars have such legally mandated and regulated “birthdates”. Hence we have the unique opportunity to study the presence of coarse information processing within the same dataset and decision problem but across two separate domains. We document that discontinuities in these two domains are of comparable size. While Lacetera et al. (2012) explain their result with a left-digit bias in the processing of numerical information, vintage discontinuities cannot be explained by this. We propose a slightly more general model of information prominence and availability bias to accommodate our findings.

Keywords: Complex Goods; Price Discontinuities; Information Neglect; Heuristics; Field Study

JEL classification: D12, D83, L 62

Full text in pdf format:

505.pdf

Reciprocity in Organisations - Evidence from the UK

Abstract:

Recent laboratory evidence suggests that personality traits, in particular social preferences, may affect contractual outcomes under moral hazard. Using the British Workplace Employment Relations Survey 2004 we find that behaviour of employers and employees is consistent with the presence of gift-exchange motives: firms that screen applicants for personality are less likely to pay low wages and more likely to provide (non-pecuniary) benefits. Firms likewise benefit from employee screening as they can implement more team-working and are generally more successful. Other human resource management practices only poorly predict these patterns. Moreover, there is no association between dismissals and personality tests, indicating that personality tests do not merely improve the fit between applicant and employer. Hence, we conclude that motivation based on gift-exchange motives is a plausible explanation for our results.

Keywords: Reciprocity, Organisational Structure, Employee Compensation

JEL Classification: D22, M52

Full text in pdf format:

504.pdf

Complementarities of HRM Practices - A Case for Employing Multiple Methods and Integrating Multiple Fields

Abstract:

We provide an overview over different literature streams that aim at explaining the origin of persistent productivity differences across organizations by variation in the use of management practices. We focus on human resource management (HRM) practices, document gaps in the literature, and show how insights from behavioral economics can inform the analysis. To this end, we develop a simple agency model illustrating how social preferences influence the design and impact of incentive schemes, investigate how auxiliary HRM practices can strengthen this interaction, and provide an overview over empirical investigations of this questions. Finally, we identify avenues for further research in this field.

Keywords: Complementarities; HRM practices; Method mix; Social preferences; Persistent Productivity Differences.

JEL Classification Numbers: D22, M50, M52.

Full text in pdf format:

503-1.pdf

Delegating Pricing Power to Customers: Pay What You Want or Name Your Own Price?

Abstract:

Pay What You Want (PWYW) and Name Your Own Price (NYOP) are customerdriven pricing mechanisms that give customers (some) pricing power. Both have been used in service industries with high fixed capacity costs in order to appeal to additional customers by reducing prices without setting a reference price. In this experimental study we compare the functioning and the performance of these two pricing mechanisms. We show that both mechanisms can be successfully used to endogenously price discriminate. PWYW can be very successful if there is an additional promotional benefit to using PWYW and if marginal costs are not too high. PWYW is a very aggressive competitive strategy that achieves almost full market penetration. NYOP is a less aggressive strategy that can also be used if marginal costs are high. It reduces price competition and segments the market. Low valuation customers are more likely to use NYOP while high valuation customers prefer a posted price seller.

JEL Classification Numbers: D03, D21, D22, D40, L11, M31

Keywords: Customer-driven pricing mechanisms; Pay What You Want; Name Your Own Price; Competitive Strategies; Marketing; Laboratory Experiment.

Full text in pdf format:

501.pdf

Auctions vs. Negotiations: The Effects of Inefficient Renegotiation

Abstract:

For the procurement of complex goods the early exchange of information is important to avoid costly renegotiation ex post. We show that this is achieved by bilateral negotiations but not by auctions. Negotiations strictly outperforms auctions if sellers are likely to have superior information about possible design improvements, if renegotiation is costly, and if the buyer's bargaining position is sufficiently strong. Moreover, we show that negotiations provide stronger incentives for sellers to investigate possible design improvements than auctions. This provides an explanation for the widespread use of negotiations as a procurement mechanism in private industry.

JEL classification numbers: D03; D82; D83; H57.

Keywords: Auctions; Negotiations; Procurement; Renegotiation; Adaptation Costs; Loss Aversion; Behavioral Contract Theory.

Full text in pdf format:

484.pdf

Dynamic Oligopoly Pricing: Evidence from the Airline Industry

Abstract:

We explore how pricing dynamics in the European airline industry vary with the competitive environment. Our results highlight substantial variations in pricing dynamics that are consistent with a theory of intertemporal price discrimination. First, the rate at which prices increase towards the scheduled travel date is decreasing in competition, supporting the idea that competition restrains the ability of airlines to price-discriminate. Second, the sensitivity to competition is substantially increasing in the heterogeneity of the customer base, reflecting further that restraints on price discrimination are only relevant if there is initial scope for price discrimination. These patterns are quantitatively important, explaining about 83 percent of the total within-flight price dispersion, and explaining 17 percent of the observed cross-market variation of pricing dynamics.

Keywords: Airline industry, capacity constraints, dynamic oligopoly pricing, intertemporal price dispersion, price discrimination.

JEL Classification: D43, D92, L11, L93.

Full text in pdf format:

463.pdf

Optimal Delegated Search with Adverse Selection and Moral Hazard

Abstract:

The paper studies a model of delegated search. The distribution of search revenues is unknown to the principal and has to be elicited from the agent in order to design the optimal search policy. At the same time, the search process is unobservable, requiring search to be self-enforcing. The two information asymmetries are mutually enforcing each other; if one is relaxed, delegated search is efficient. With both asymmetries prevailing simultaneously, search is almost surely inefficient (it is stopped too early). Second-best remuneration is shown to optimally utilize a menu of simple bonus contracts. In contrast to standard adverse selection problems, indirect nonlinear tariffs are strictly dominated.

Keywords: adverse selection, bonus contracts, delegated search, moral hazard,

optimal stopping.

JEL Classification: D82, D83, D86, C72.

Full text in pdf format:

462.pdf

Emergence and Persistence of Extreme Political Systems

Abstract:

We investigate the dynamics of political systems in a framework where transitions are driven by reforms and revolts, and where political systems are a priori unconstrained, ranging continuously from single-man dictatorships to full-scale democracies. The dynamics are governed by the likelihood of transitions and their outcome, which are both determined endogenously. We find that reforms and revolts result in extreme political systems - reforms by enfranchising the majority of the population leading to democracies, and revolts by installing autocracies. Reinforcing this polarization, extreme political systems are persistent across time: Democracies are intrinsically stable, leading to long episodes without political change. Autocracies, in contrast, are subject to frequent regime changes. Nevertheless they are persistent, since ensuing revolts lead to autocracies comparable to their predecessors. Taken together, our results suggest that the long-run distribution of political systems is bimodal with mass concentrated on the extremes. The dynamics are consistent with cross-country data.

Keywords: Endogenous dynamics of political systems, invariant distribution, persistence

of regime types, polarization, transition paths, unrestricted polity space.

JEL Classification: D74, D78, P16.

Full text in pdf format:

461.pdf

Transmission and Generation Investment in Electricity Markets: The Effects of Market Splitting and Network Fee Regimes

Abstract:

In this paper we propose a three–level computational equilibrium model that allows to analyze the impact of the regulatory environment on transmission line expansion (by the regulator) and investment in generation capacity (by private firms) in liberalized electricity markets. The basic model analyzes investment decisions of the transmission operator (TO) and private firms in expectation of an energy only market and cost-based redispatch. In different specifications we consider the cases of one versus two price zones (market splitting) and analyze different approaches to recover network cost, in particular lump sum, capacity based, and energy based fees. In order to compare the outcomes of our multi–stage market model with the first best benchmark, we also solve the corresponding integrated planer problem. In two simple test networks we illustrate that energy only markets can lead to suboptimal locational decisions for generation capacity and thus, imply excessive network expansion. Market splitting heals those problems only partially. Those results obtain for both, capacity and energy based network tariffs, although investment slightly differs across those regimes.

Keywords: Electricity markets, Network Expansion, Generation Expansion, Investment Incentives, Computational Equilibrium Models, Transmission Management

Full text in pdf format:

460.pdf

Transparency in Buyer-Determined Auctions: Should Quality be Private or Public?

Abstract:

We study non-binding procurement auctions where both price and non-price characteristics of bidders matter for being awarded a contract. The outcome of such

auctions critically depends on how information is distributed among bidders during the bidding process. As we show theoretically, whether it is in the buyer's interest to conceal or to disclose non-price information most importantly depends on how important the quality aspects of the good to be procured are to the buyer: The more important the quality aspects are to the buyer, the more interesting concealment becomes. We then empirically study the impact of a change in the information structure using data from a large European online procurement platform for different categories of goods. In a counterfactual analysis we analyze the reduction of non-price information available to the bidders. In the data we find that the choice of information structure indeed matters. Confirming the hypothesis obtained in our theoretical framework, we find that in auction categories where bidders' non-price characteristics are of little importance for the decisions of the buyers, concealment of non-price information decreases buyers' welfare by up to 6% due to reduced competitive pressure leading to higher bids. In contrast, for categories where bidders' non-price characteristics strongly influence buyers' decisions concealment of non-price information increases buyers' welfare by up to 15%.

Keywords: Procurement, Non-Binding Auctions, Supply Chain Management

Full text in pdf format:

459.pdf

Promises and Image Concerns

Abstract:

According to several psychological and economic studies, non-binding communication can be an effective tool to increase trust and enhance cooperation. This paper focuses on reasons why people stick to a given promise and analyzes to what extent image concerns of being perceived as a promise breaker play a role. In a controlled laboratory experiment, we vary the ex post observability of the promising party's action in order to test for social image concerns. We observe that slightly more promises are kept if the action is revealed than if it is not, yet the difference is not significant. However, a variation in the selection of pre-defined messages across treatments delivers another interesting finding. While most of the promises are kept, statements of intent tend to be broken.

Keywords: Promises, communication, social image concerns, guilt, shame, behavioral economics, experiment

JEL-Classification: C70, C91, D03, D82

Full text in pdf format:

458.pdf

Do Women Have More Shame than Men? An Experiment on Self-Assessment and the Shame of Overestimating Oneself

Abstract:

We analyze how subjects' self-assessment depends on whether its accuracy is observable to others. We find that women downgrade their self-assessment given observability while men do not. Women avoid the shame they may have if others observe that they overestimated themselves. Men, however, do not seem to be similarly shame-averse. This gender difference may be due to different societal expectations: While we find that men are expected to be overconfident, women are not. Shame-aversion may explain recent findings that women shy away from competition, demanding jobs and wage negotiations, as entering these situations shows a certain confidence of one's ability.

Keywords: Gender, Shame, Self-confidence, Overconfidence, Experiment

JEL-Classification: C91, D03, J16

Full text in pdf format:

457.pdf

Professional norms and physician behavior: homo oeconomicus or homo hippocraticus?

Abstract:

Physicians' treatment decisions determine the level of health care spending to a large extent. The analysis of physician agency describes how doctors trade off their own and their patients' benefits, with a third party (such as the collective of insured individuals or the taxpayers) bearing the costs. Professional norms are viewed as restraining physicians' self-interest and as introducing altruism towards the patient. We present a controlled experiment that analyzes the impact of professional norms on prospective physicians' trade-offs between her own profits, the patients' benefits, and the payers' expenses for medical care. We find that professional norms derived from the Hippocratic tradition shift weight to the patient in the physician's decisions while decreasing his self-interest and efficiency concerns.

Keywords: social preferences, allocation of medical resources, professional norms

JEL classification: A13, I19, C72, C91

Full text in pdf format:

456_01.pdf

Incomplete Contracting, Renegotiation, and Expectation-Based Loss Aversion

Abstract:

We consider a simple trading relationship between an expectation-based loss-averse buyer and profit-maximizing sellers. When writing a long-term contract the parties have to rely on renegotiations in order to ensure materially efficient trade ex post. The type of the concluded long-term contract affects the buyer’s expectations regarding the outcome of renegotiation. If the buyer expects renegotiation always to take place, the parties are always able to implement the materially efficient good ex post. It can be optimal for the buyer, however, to expect that renegotiation does not take place. In this case, a good of too high quality or too low quality is traded ex post. Based on the buyer’s expectation management, our theory provides a rationale for “employment contracts” in the absence of non-contractible investments. Moreover, in an extension with non-contractible investments, we show that loss aversion can reduce the hold-up problem.

JEL classification: C78; D03; D86

Keywords: Behavioral Contract Theory; Expectation-Based Loss Aversion; Incomplete Contracts; Renegotiation

Full text in pdf format:

454.pdf

Overconfidence in the Markets for Lemons

Abstract:

We extend Akerlof (1970)’s “Market for Lemons” by assuming that some buyers are overconfident. Buyers in our model receive a noisy signal about the quality of the good that is on display for sale. Overconfident buyers do not update according to Bayes’ rule but take the noisy signal at face value. We show that the presence of overconfident buyers can stabilize the market outcome by preventing total adverse selection. This stabilization, however, comes at a cost: rational buyers are crowded out of the market.

JEL:  D82; L15

Keywords: Adverse Selection; Market for Lemons; Overconfidence

Full text in pdf format:

452.pdf

Pay What You Want as a Marketing Strategy in Monopolistic and Competitive Markets

Abstract:

Pay What You Want (PWYW) can be an attractive marketing strategy to price discriminate between fair-minded and selfish customers, to fully penetrate a market without giving away the product for free, and to undercut competitors that use posted prices. We report on laboratory experiments that identify causal factors determining the willingness of buyers to pay voluntarily under PWYW. Furthermore, to see how competition affects the viability of PWYW, we implement markets in which a PWYW seller competes with a traditional seller. Finally, we endogenize the market structure and let sellers choose their pricing strategy. The experimental results show that outcome-based social preferences and strategic considerations to keep the seller in the market can explain why and how much buyers pay voluntarily to a PWYW seller. We find that PWYW can be viable in isolation, but it is less successful as a competitive strategy because it does not drive traditional posted-price sellers out of the market. Instead, the existence of a posted-price competitor reduces buyers’ payments and prevents the PWYW seller from fully penetrating the market. If given the choice, the majority of sellers opt for setting a posted price rather than a PWYW pricing. We discuss the implications of these results for the use of PWYW as a marketing strategy.
Keywords: customer-driven pricing mechanisms; pay what you want; revenue management; price discrimination; social preferences.

Full text in pdf format:

393.pdf

You Owe Me

Abstract:

In many cultures and industries gifts are given in order to influence the recipient, often at the expense of a third party. Examples include business gifts of firms and lobbyists. In a series of experiments, we show that, even without incentive or in-formational effects, small gifts strongly influence the recipient’s behavior in favor of the gift giver, in particular when a third party bears the cost. Subjects are well aware that the gift is given to influence their behavior but reciprocate nevertheless. Withholding the gift triggers a strong negative response. These findings are incon-sistent with the most prominent models of social preferences. We propose an ex-tension of existing theories to capture the observed behavior by endogenizing the “reference group” to whom social preferences are applied. We also show that dis-closure and size limits are not effective in reducing the effect of gifts, consistent with our model. Financial incentives ameliorate the effect of the gift but backfire when available but not provided.
Keywords: Gift exchange; externalities; lobbyism; corruption; reciprocity; social preferences.
JEL: C91, D73, I11.

Full text in pdf format:

392.pdf

Use and Abuse of Authority A Behavioral Foundation of the Employment Relation

Abstract:

Abstract: Employment contracts give a principal the authority to decide flexibly which task his agent should execute. However, there is a tradeoff, first pointed out by Simon (1951), between flexibility and employer moral hazard. An employment contract allows the principal to adjust the task quickly to the realization of the state of the world, but he may also abuse this flexibility to exploit the agent. We capture this tradeoff in an experimental design and show that principals exhibit a strong preference for the employment contract. However, selfish principals exploit agents in one-shot interactions, inducing them to resist entering into employment contracts. This resistance to employment contracts vanishes if fairness preferences in combination with reputation opportunities keep principals from abusing their power, leading to the widespread, endogenous formation of efficient long-run employment relations. Our results inform the theory of the firm by showing how behavioral forces shape an important transaction cost of integration – the abuse of authority – and by providing an empirical basis for assessing differences between the Marxian and the Coasian view of the firm, as well as Alchian and Demsetz’s (1972) critique of the Coasian approach.
Keywords: theory of the firm, transaction cost economics, authority, power abuse, employment relation, fairness, reputation
JEL: C91, D23, D86, M5

Full text in pdf format:

391.pdf

A Theory of Ex Post Inefficient Renegotiation

Abstract:

We propose a theory of ex post inefficient renegotiation that is based on loss aversion. When two parties write a long-term contract that has to be renegotiated after the realization of the state of the world, they take the initial contract as a reference point to which they compare gains and losses of the renegotiated transaction. We show that loss aversion makes the renegotiated outcome sticky and materially inefficient. The theory has important implications for the optimal design of long-term contracts. First, it explains why parties often abstain from writing a beneficial long-term contract or why some contracts specify transactions that are never ex post efficient. Second, it shows under what conditions parties should rely on the allocation of ownership rights to protect relationship-specific investments rather than writing a specific performance contract. Third, it shows that employment contracts can be strictly optimal even if parties are free to renegotiate.

JEL classification: C78; D03; D86.

Keywords: Renegotiation; Incomplete Contracts; Reference Points; Employment Contracts; Behavioral Contract Theory.

Full text in pdf format:

390.pdf

The Expectation-Based Loss-Averse Newsvendor

Abstract:

We modify the classic single-period inventory management problem by assuming that the newsvendor is expectation-based loss averse according to Köszegi and Rabin (2006, 2007). Expectation-based loss aversion leads to an endogenous psychological cost of leftovers as well as stockouts. If there are no monetary stockout costs, then the loss-averse newsvendor orders a quantity lower than the quantity ordered by a profit-maximizing newsvendor. If there are positive monetary costs associated with stockouts, then the loss-averse newsvendor places suboptimal orders, which can be either too high or too low.

Keywords: behavioral operations management; inventory decision; loss aversion; newsvendor

Full text in pdf format:

389.pdf

Reference Points in Renegotiations: The Role of Contracts and Competition

Abstract:

Several recent papers argue that contracts provide reference points that affect ex post behavior. We test this hypothesis in a canonical buyer-seller relationship with renegotiation. Our paper provides causal experimental evidence that an initial contract has a highly significant and economically important impact on renegotiation behavior that goes beyond the effect of contracts on bargaining threatpoints. We compare situations in which an initial contract is renegotiated to strategically equivalent bargaining situations in which no ex ante contract was written. The ex ante contract causes sellers to ask for markups that are 45 percent lower than in strategically equivalent bargaining situations without an initial contract. Moreover, buyers are more likely to reject given markups in renegotiations than in negotiations. We do not find that these effects are stronger when the initial contract is concluded under competitive rather than monopolistic conditions.

Keywords: renegotiation, bargaining, reference points, contracts, competition

JEL: C78, C91, D03, D86

Full text in pdf format:

385.pdf

Plan Selection in Medicare Part D: Evidence from administrative Data

Abstract:

We study the Medicare Part D prescription drug insurance program as a bellwether for designs of private, non-mandatory health insurance markets, focusing on the ability of consumers to evaluate and optimize their choices of plans. Our analysis of administrative data on medical claims in Medicare Part D suggests that less than 10 percent of individuals enroll in plans that are ex post optimal with respect to total cost (premiums and co-payments). Relative to the benchmark of a static decision rule, similar to the Plan Finder provided by the Medicare administration, that conditions next year’s plan choice only on the drugs consumed in the current year, enrollees lost on average about $300 per year. These numbers are hard to reconcile with decision costs alone; it appears that unless a sizeable fraction of consumers value plan features other than cost, they are not optimizing effectively.

Full text in pdf format:

384_01.pdf

Discretion, Productivity and Work Satisfaction

Abstract:

In Bartling, Fehr and Schmidt (2012) we show theoretically and experimentally that it is optimal to grant discretion to workers if (i) discretion increases productivity, (ii) workers can be screened by past performance, (iii) some workers reciprocate high wages with high effort and (iv) employers pay high wages leaving rents to their workers. In this paper we show experimentally that the productivity increase due to discretion is not only sufficient but also necessary for the optimality of granting discretion to workers. Furthermore, we report representative survey evidence on the impact of discretion on workers’ welfare, confirming that workers earn rents.

Keywords: high-performance work systems, wages, discretion, gift exchange, job satisfaction.

JEL: M5, J3

Full text in pdf format:

383.pdf

Delegation and Rewards

Abstract:

We study experimentally whether anti-corruption policies with a focus on bribery might be insufficient to uncover more subtle ways of gaining an unfair advantage. In particular, we investigate whether an implicit agreement to exchange favors between a decision-maker and a lobbying party serves as a legal substitute for corruption. Due to the obvious lack of field data on these activities, the laboratory provides an excellent opportunity to study this question. We find that even the pure anticipation of future rewards from a lobbying party suffices to bias a decision-maker in favor of this party, even though it creates negative externalities to others. Although future rewards are not contractible, the benefitting party voluntarily compensates decision-makers for partisan choices. In this way, both receive higher payoffs, but aggregate welfare is lower than without a rewards channel. Thus, the outcome mirrors what might have been achieved via conventional bribing, while not being illegal.
Keywords: delegation, gift exchange, corruption, lobbying, negative externalities
JEL classification: C91, D62, D63, D73, K42

Full text in pdf format:

378.pdf

Risk attitudes and Medicare Part D enrollment decisions

Abstract:

The new Medicare Part D program provides prescription drug coverage for older Americans through highly subsidized and tightly regulated plans offered by private insurance firms. For most eligible individuals without coverage from other sources, obtaining Part D coverage would be rational, but it requires active enrollment and plan choice decisions. We investigate if non-enrollment in Medicare Part D can partly be explained by risk aversion. Data are taken from a national online survey conducted just after the introduction Part D. The survey included a context-free and a context-related hypothetical lottery to measure an individual’s attitude towards risk. Respondents who are risk tolerant according to these measures were significantly less likely to enroll in Part D. We also illustrate that hypothetical choice questions designed to elicit risk attitudes are subject to reference-point effects. Even minor differences in the priming of respondents can result in potentially misleading conclusions about the role of risk aversion in the insurance decisions.
Keywords: Risk aversion, Medicare Part D, heterogeneous preferences, insurance demand, survey design
JEL classification: D03, D81, H51, I1

Full text in pdf format:

373.pdf

The Impact of the Internet on Retail Competition: Evidence from Technological Differences in Internet Access

Abstract:

Does the internet increase competition? To address this question, I exploit two institutional details unique to Germany: (1) Some municipalities received glass fibre cables that cannot be upgraded to DSL; I use these municipalities as a treatment group with reduced online competition. (2) German law mandates resale price maintenance for books; I compare three retailing sectors, electronics (price competition), books (no price competition), and food (no online sales), to identify the effect of price competition: The effect of price competition is highly significant. Full broadband access reduces offline electronics retailers’ producer rents by 1.5 percent per year from 1999 to 2007.

Keywords: Internet, Market Structure, Retail Competition, Differences in Differences
JEL Classification: D43, L81, L13

November 2010

Full text in pdf format:

345.pdf

Free Riding in the Lab and in the Field

Abstract:

We run a public good experiment in the field and in the lab with (partly) the same subjects. The field experiment is a true natural field experiment as subjects do not know that they are exposed to an experimental variation. We can show that subjects' behavior in the classic lab public good experiment correlates with their behavior in the structurally comparable public good treatment in the field but not with behavior in any of two control treatments we ran in the field. This effect is also economically significant. We conclude that a) the classic lab public good experiment captures important aspects of structurally equivalent real life situations and b) that behavior in lab and field at least in our setting is driven by the same underlying forces.

Keywords: Field and Lab Experiments, External Validity, Public Goods, Team Production

JEL Classification: C91,C93,D01,D64

September 2010

Full text in pdf format:

344.pdf

Standards, Innovation Incentives, and the Formation of Patent Pools

Abstract:

Technological standards give rise to a complements problem that affects pricing and innovation incentives of technology producers. In this paper I discuss how patent pools can be used to solve these problems and what incentives patent holders have to form a patent pool. I offer some suggestions how competition authorities can foster the formation of welfare increasing patent pools.

Keywords: Patent pools, standard setting organisations, innovation, complements problem, patent thicket
JEL Classification: L15, L24, O3

November 2010

Full text in pdf format:

342.pdf

Fairness and Cheating

Abstract:

We present evidence from a laboratory experiment showing that individuals who believe they were treated unfairly in an interaction with another person are more likely to cheat in a subsequent unrelated game. Specifically, subjects first participated in a dictator game. They then flipped a coin in private and reported the outcome. Subjects could increase their total payoff by cheating, i.e., lying about the outcome of the coin toss. We found that subjects were more likely to cheat in reporting the outcome of the coin flip when: 1) they received either nothing or a very small transfer from the dictator; and 2) they claimed to have been treated unfairly. This is consistent with the view that experiencing a norm violation is sufficient to justify the violation of another norm at the expense of a third party. This result extends the growing literature on social norms.

Keywords: cheating; social norms; experimental design
JEL Classification: C91; D03; D63

September 2010

Full text in pdf format:

335.pdf

Uncertain Demand, Consumer Loss Aversion, and Flat-Rate Tariffs

Abstract:

The so called flat-rate bias is a well documented phenomenon caused by consumers' desire to be insured against fluctuations in their billing amounts. This paper shows that expectation-based loss aversion provides a formal explanation for this bias. We solve for the optimal two-part tariff when contracting with loss-averse consumers who are uncertain about their demand. The optimal tariff is a flat rate if marginal cost of production is low compared to a consumer's degree of loss aversion and if there is enough variation in the consumer's demand. Moreover, if consumers differ with respect to the degree of loss aversion, firms' optimal menu of tariffs typically comprises a flat-rate contract.

Keywords: Consumer Loss Aversion; Flat-Rate Tariffs; Nonlinear Pricing; Uncertain Demand

JEL Classification: D11; D43; L11

July 2010

Full text in pdf format:

330.pdf

Optimal Incentive Contracts under Moral Hazard When the Agent is Free to Leave

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.

Keywords: moral hazard, limited commitment, ex-post outside option, limited liability
JEL Classification: D86, D82, K31, M52

July 2010

Full text in pdf format:

329.pdf

Commitment in R&D Tournaments via Strategic Delegation to Overoptimistic Managers

Abstract:

This paper shows that it is profitable for a firm to hire an overoptimistic manager to commit to a certain investment strategy in an R&D tournament situation. In the unique symmetric equilibrium, all firms delegate to overoptimistic managers, where the optimal degree of overoptimism depends on the riskiness of the tournament. In these situations a manager’s type may serve as a substitute for delegation via contracts. By delegating to overoptimistic managers, firms can escape the rat race nature of R&D tournaments.

Keywords: Strategic Delegation, Overoptimism, Tournaments

JEL Classification: J 32, J 33, M 12

July 2010

Full text in pdf format:

328.pdf

Incentives, Reputation and the Allocation of Authority

Abstract:

We address the question how much authority a principal should delegate to a manager with conflicting interests and uncertain ability in a context in which the manager has both compensationbased and reputational incentives. The optimal level of authority balances the value of the manager’s decision-making expertise against the cost of ensuring that the manager uses his discretion productively. Reputational incentives reduce the necessary monetary incentives to discourage purely opportunistic behavior, but may cause the manager to pursue conservative courses of action to preserve his reputation. This undermines the benefits of delegating control, leading to decreased  managerial authority and stronger monetary incentives. When the principal can commit to long-term contracts, she eliminates this conservative bias by rewarding a successful manager with greater future compensation and authority than would be optimal in a static setting. Early in the relationship the principal may delegate additional authority in order to screen for managers of high ability.

Keywords: Agency Problems; Delegation; Compensation Contracts; Job Design; Career Concerns; Managerial Conservatism

JEL Classification: D86, L14, L23, M52, M54

July 2010

Full text in pdf format:

327.pdf

Determinants and Effects of Reserve Prices in Hattrick Auctions

Abstract:

We use a unique hand collected data set of 6,258 auctions from the online football manager game Hattrick to study determinants and effects of reserve prices. We find that chosen reserve prices exhibit both very sophisticated and suboptimal behavior by the sellers. On the one hand, reserve prices are adjusted remarkably nuanced to the resulting sales price pattern. However, reserve prices are too clustered at zero and at multiples of e 50,000 as to be consistent with fully rational behavior. We recover the value distribution and simulate the loss in expected revenue from suboptimal reserve prices. Finally, we find evidence for the sunk cost fallacy as there is a substantial positive effect on the reserve price when the player has been acquired previously.

Keywords: Reserve Price, Auction Revenue, Inattention, Price Clusters, Sunk Cost Fallacy

JEL Classification: D12, D44

July 2010

Full text in pdf format:

326.pdf

Unique Equilibrium in Two-Part Tariff Competition between Two-Sided Platforms

Abstract:

Two-sided market models in which platforms compete via two-part tariffs, i.e. a subscription and a per-transaction fee, are often plagued by a continuum of equilibria. This paper augments existing models by allowing for heterogeneous rading behavior of agents on both sides. We show that this simple method yields a unique equilibrium even in the limit as the heterogeneity vanishes. In case of competitive bottlenecks we find that in this equilibrium platforms benefit from the possibility to price discriminate if per-transaction costs are relatively large. This is the case because two-part tariffs allow platforms to better distribute these costs among the two sides. Under two-sided single-homing price discrimination hurts platforms if per-transaction fees can be negative.

Keywords: Two-Sided Markets, Per-Transaction Fee, Subscription Fee, Two-Part
Tariffs, Unique Equilibrium

JEL Classification: D43, L13

February 2010

Full text in pdf format:

308.pdf

Can intentions spoil the kindness of a gift? - An experimental study

Abstract:

Consider a situation where person A undertakes acostly action that benefits person B. This behavior seems altruistic. However, if A expects a reward in return from B, then A's action may be motivated by expected rewards rather than by pure altruism. The question we address in this experimental study is how B reacts to A's intentions. We vary the probability that the second mover in a trust game can reciprocate and analyze effects on second mover behavior. Our results suggest that expected rewards do not spoil the perceived kindness of an action and the action's rewards.

Keywords: social preferences, intentions, beliefs, psychological game theory, experiment

JEL Classification:C91, D03, D64

October 2009

Full text in pdf format:

302.pdf

Social Preferences and Competition

Abstract:

There is a general presumption that social preferences can be ignored if markets are competitive. Market experiments (Smith 1962) and recent theoretical results (Dufwenberg et al. 2008) suggest that competition forces people to behave as if they were purely self-interested. We qualify this view. Social preferences are irrelevant if and only if two conditions are met: separability of preferences and completeness of contracts. These conditions are often plausible, but they fail to hold when uncertainty is important (financial markets) or when incomplete contracts are traded (labor markets). Social preferences can explain many of the anomalies frequently observed on these markets.

Keywords: Social preferences, competition, separability, incomplete contracts, asset markets, labor markets

JEL Classification: C9, D5, J0

December 2009

Full text in pdf format:

298.pdf

Screening, Competition, and Job Design Economic Origins of Good Jobs

Abstract:

In recent decades, many firms offered more discretion to their employees, often increasing the productivity of effort but also leaving more opportunities for shirking. These “high-performance work systems” are difficult to understand in terms of standard moral hazard models. We show experimentally that complementarities between high effort discretion, rent-sharing, screening opportunities, and competition are important driving forces behind these new forms of work organization. We document in particular the endogenous emergence of two fundamentally istinct types of employment strategies. Employers either implement a control strategy, which consists of low effort discretion and little or no rent-sharing, or they implement a trust strategy, which stipulates high effort discretion and substantial rent-sharing. If employers cannot screen employees, the control strategy prevails, while the possibility of screening renders the trust strategy profitable. The introduction of competition substantially fosters the trust strategy, reduces market segmentation, and leads to large welfare gains for both employers and employees.

Keywords: job design, high-performance work systems, screening, reputation, competition, trust, control, social preferences, complementarities

JEL Classification:C91, D86

January 2009

Full text in pdf format:

297.pdf

Fairness: A Critique to the Utilitarian Approach

Abstract:

We address a basic diffculty with incorporating fairness into standard utilitarian
choice theories. Standard utilitarian theories evaluate lotteries according to the (weighted) utility over final outcomes and assume in particular that a lottery is never preferred over getting the most preferred underlying outcome with ertainty. While nearly universally adopted in economics (including behavioral economics) and appealing for choices among consumption goods, this approach is problematic when choices directly affect the payoffs of other individuals. A difficulty is that randomization may in itself be valued as a desirable procedure for allocating scarce resources. We highlight this in two simple choice settings. Individuals can choose between three options: to get more money; to get less money and someo ther good; to flip a coin between these two alternatives. When the good is a regular consumption good like a coffeemug, hardly any of our subjects randomize. When the good is a social good that yields payoffs directly to some other individual,nearly a third of our subjects choose to randomize. Our results indicate that fairness concerns are conducive to behavioral anomalies that the standard utilitarian model cannot accommodate.

Keywords: risky choice, betweenness axiom, social preferences, preference for randomness

JEL Classification: D81, C91, D63

November 2009

Full text in pdf format:

288.pdf

Competitive Effects of Vertical Integration with Downstream Oligopsony and Oligopoly

Abstract:

We analyze the competitive effects of backward vertical integration by a partially vertically integrated firm that competes with non-integrated firms both upstream and downstream. We show that vertical integration is procompetitive under fairly general conditions. It can be anticompetitive only if the ex ante degree of integration is relatively large. Interestingly, vertical integration is more likely to be anticompetitive if the industry is less concentrated. These results are in line with recent empirical evidence. In addition, we show that even when vertical integration is procompetitive, it is not necessarily welfare enhancing.

Keywords: Vertical Integration, Downstream Oligopsony, Downstream Oligopoly, Competition Policy, Capacity Choice

JEL Classification: D43, L41, L42

October 2009

Full text in pdf format:

278.pdf

An Experimental study on the information structure in teams

Abstract:

Is free-riding in teams reduced when one member receives a signal on his colleagueís performance? And how does free-riding depend on the signal's type? We address these questions in experimental teams in which two agents sequentially exert effort to contribute to the team output. We vary the type of information the second mover receives prior to his effort choice and find that agents work more when signals are available. Overall, behavior differs from predictions of standard theory. Signals that are predicted to have no effect are, in fact, influential and signals that are predicted to have an effect are redundant.

Keywords: Team production, Free-riding, Experiment, Information, Signal

JEL Classification: C92, J30, M50, D82

September 2009

Full text in pdf format:

277.pdf

Licensing Complementary Patents: “Patent Trolls”, Market Structure, and “Excessive” Royalties

Abstract:

The infamous Blackberry case brought new attention to so-called “patent trolls” and began the general association of trolls with “non-practicing” patent holders. This has had important legal consequences: Namely, patent holders have been denied injunctive relief because they did not practice the patents themselves. In this paper we analyze how patent holders –– both non-practicing and vertically integrated –– choose their royalties depending on the structure of the upstream and downstream markets and the types of licensing agreements available. We show that a vertically integrated firm has an incentive to raise its rivals’ costs and to restrict entry on the downstream market; incentives that do not hold for non-integrated patent holders. An automatic presumption that a non-integrated patent holder will charge higher royalties than a vertically integrated company is therefore unfounded. Whether a company charges “excessive” royalties depends on whether there is scope for hold-up, either because of sunk investments on the part of potential licensees or because of “weak” patents held by the licensor. These factors are orthogonal to whether patent holders are practicing or not

September 2009

Full text in pdf format:

275.pdf

Complementary Patents and Market Structure

Abstract:

Many high technology goods are based on standards that require several essential patents owned by different IP holders. This gives rise to a complements and a double mark-up problem. We compare the welfare effects of two different business strategies dealing with these problems. Vertical integration of an IP holder and a downstream producer solves the double mark-up problem between these firms. Nevertheless, it may raise royalty rates and reduce output as compared to non-integration. Horizontal integration of IP holders solves the complements problem but not the double mark-up problem. Vertical integration discourages entry and reduces innovation incentives, while horizontal integration always benefits from entry and innovation

Keywords: IP rights, complementary patents, standards, licensing, patent pool, vertical integration

JEL Classification:  L1, L4.

September 2009

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274.pdf

On Inequity Aversion - A Reply to Binmore and Shaked

Abstract:

In this paper we reply to Binmore and Shaked’s criticism of the Fehr-Schmidt model of inequity aversion. We put the theory and their arguments into perspective and show that their criticism is not substantiated. Finally, we briefly comment on the main challenges for future research on social preferences. 

Keywords: Experiments, other-regarding preferences, inequity aversion, 
JEL Classification: B41, C90

Febuary 2009

Full text in pdf format:

256.pdf

Indirect Taxation in Vertical Oligopoly

Abstract:

This paper analyzes the effects of specific and ad valorem taxation in an industry with downstream and upstream oligopoly. We find that in the short run, i.e. when the number of firms in both markets is exogenous, the results concerning tax incidence tend to be qualitatively similar to models where the upstream market is perfectly competitive. However, both over- and undershifting are more pronounced, potentially to a very large extent. Instead, in the long run under endogenous entry and exit overshifting of both taxes is more likely to occur and is more pronounced under upstream oligopoly. As a result of this, a tax increase is more likely to be welfare reducing. We also demonstrate that downstream and upstream taxation are equivalent in the short run while this is not true for the ad valorem tax in the long run. We show that it is normally more efficient to tax downstream.

Keywords: Specific Tax, Ad Valorem Tax, Value-Added Tax, Tax Incidence, Tax Efficiency, Indirect Taxation, Imperfect Competition, Vertical Oligopoly

JEL Classification: D43, H21, H22, L13

Febuary 2009

Full text in pdf format:

255.pdf

The Role of Experiments for the Development of Economic Theories

Abstract:

Economic experiments interact with economic theories in various ways. First of all they are used to test economic theories. However, they can neither confirm nor falsify them in a strict sense. They rather inform us about the range of applicability, the robustness and the predictive power of a theory. Furthermore, economic experiments discover and isolate phenomena and challenge economic theorists to explain them. Finally, many economic experiments are “material” models. They are used to analyse and predict how changes in the environment affect economic outcomes. However, they cannot offer an explanation for what we observe. This has to be provided by economic theory.

Keywords: Economic experiments, economic theories, falsification, confirmation, phenomena, models
JEL Classification: B41, C90

January 2009

Full text in pdf format:

252.pdf

Complementary Patents and Market Structure

Abstract:

Many high technology goods are based on standards that require access to several patents that are owned by different IP holders. We investigate the royalties chosen by IP holders under different market structures. Vertical integration of an IP holder and a downstream producer solves the double mark-up problem between these firms. Nevertheless, it may raise royalty rates and reduce output as compared to non-integration. Horizontal integration of IP holders (or a patent pool) solves the complements problem but not the double mark-up problem. Vertical integration discourages entry and reduces innovation incentives, while horizontal integration always encourages entry and innovation.

Keywords: IP rights, complementary patents, standards, licensing, patent pool, vertical integration.
JEL Classification: L15, O31, L24, O32, K11.

September 2008

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249.pdf

How to Determine whether Regional Markets are Integrated? Theory and Evidence from European Electricity Markets

Abstract:

Prices may di er between regional markets if transport capacities are limited. We develop a new approach to determine to which extent such di erences stem from limited participation in cross-border trader rather than from bottlenecks. We derive a theoretical integration benchmark for the typical case where transportation markets clear before the product markets, using Grossman's (1976) notion of a rational expectations equilibrium. We compare the benchmark to data from European electricity markets. The data reject the integration hypothesis: Capacity prices contain too little information about spot price di erential; this indicates that well informed traders do not engage in cross-border trade.

Keywords: Market integration, electricity markets, interconnector,competition policy, rational expectations equilibrium
JEL Classification: G14, D84, L94
April 2008

Full text in pdf format:

236.pdf

Is the veil of ignorance only a concept about risk? An experiment

Abstract:

We implement the Rawlsian veil of ignorance in the laboratory. Our experimental design allows separating the effects of risk and social preferences behind the veil of ignorance. Subjects prefer more equal distributions behind than in front of the veil of ignorance, but only a minority acts according to maximin preferences. Men prefer more equal allocations mostly for insurance purposes, women also due to social preferences for equality. Our results contrast the Utilitarian's claim that behind the veil of ignorance maximin preferences necessarily imply infinite risk aversion. They are compatible with any degree of risk aversion as long as social preferences for equality are sufficiently strong.

Keywords: law and economics, incentives, crowding out, experiment
JEL Classification: D63, D64, C99
February 2008

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230.pdf

An experimental test of the deterrence hypothesis

Abstract:

Crime has to be punished, but does punishment reduce crime? We conduct a neutrally framed laboratory experiment to test the deterrence hypothesis, namely that crime is weakly decreasing in deterrent incentives, i.e. severity and probability of punishment. In our experiment, subjects can steal from another participant's payoff. Deterrent incentives vary across and within sessions. The across subject analysis clearly rejects the deterrence hypothesis: except for very high levels of incentives, subjects steal more the stronger the incentives. We observe two types of subjects: selfish subjects who act according to the deterrence hypothesis and fair-minded subjects for whom deterrent incentives backfire.

Keywords: deterrence, law and economics, incentives, crowding out, experiment
JEL Classification: K42, C91, D63
February 2008

Full text in pdf format:

229.pdf

A Model of Vertical Oligopolistic Competition

Abstract:

This paper develops a model of successive oligopolies with endogenous market entry, allowing for varying degrees of product differentiation and entry costs in both markets. Our analysis shows that the downstream conditions dominate the overall profitability of the two-tier structure while the upstream conditions mainly affect the distribution of profits. We compare the welfare effects of upstream versus downstream deregulation policies and show that the impact of deregulation may be overvalued when ignoring feedback effects from the other market. Furthermore, we analyze how different forms of vertical restraints influence the endogenous market structure and show when they are welfare enhancing.

Keywords: Deregulation, Free Entry, Price Competition, Product Differentiation, Successive Oligopolies, Two-Part Tariffs, Vertical Restraints
JEL Classification: L13, D43, L40, L50
February 2008

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228.pdf

Equal Sharing Rules in Partnerships

Abstract:

Partnerships are the prevalent organizational form in many industries. Most partnerships share profits equally among the partners. Following Kandel and Lazear (1992) it is often argued that "peer pressure" mitigates the arising free-rider problem. This line of reasoning takes the equal sharing rule as exogenously given. The purpose of our paper is to show that with inequity averse partners - a behavioral assumption akin to peer pressure - the equal sharing rule arises endogenously as an optimal solution to the incentive problem in a partnership.

Keywords: equal sharing rule, partnerships, incentives, peer pressure, inequity aversion
JEL Classification: D20, D86, J54
August 2007

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217.pdf

Abstract:

This paper analyzes a duopoly model with stochastic demand in which firms first choose their strategy variable and compete afterwards. Contrary to the existing literature, we show that firms do not always choose a quantity which is the variable that induces a smaller degree of competition. The reason is that demand uncertainty and the degree of substitutability have countervailing effects on variable choice. Higher uncertainty favors prices, while closer substitutability favors quantities. Moreover, for intermediate values firms choose different strategy variables in equilibrium.

Keywords: competition, strategy variables, demand uncertainty
JEL Classification: D43, L13
May 2007

Full text in pdf format:

202.pdf

Two Tales on Resale

Abstract:

In some markets vertically integrated firms sell directly to final customers hut also to independent downstream firms with whom they then compete on the downstream market. It is often argued that resellers intensify competition and benefit consumers, in particular when wholesale prices are regulated. However, we show that (i) resale may increase prices and make consumers worse off and that (ii) standard "retail minus X regulation" may increase prices and harm consumers. Our analysis suggests that this is more likely if the number of integrated firms is small, the degree of product differentiation is low, and/or if competition is spatial.

Keywords: Resale regulation, wholesale, spatial product differentiation, non-spatial product differentiation, vertical restraints
JEL Classification: D43, L11, L42, L51
March 2007

Full text in pdf format:

198.pdf

Adding a Stick to the Carrot? The Interaction of Bonuses and Fines

Abstract:

In this paper we report on a principal-agent experiment where the principal can choose whether to rely on an unenforcable bonus contract or to combine the bonus contract with a fine if the agent’s effort falls below a minimum standard. We show that most principals do not use the fine and that the pure bonus contract is more efficient than the combined contract. Our experiment suggests that principals who are less fair are more likely to choose a combined contract and less likely to actually pay the announced bonus. This offers a new explanation for why explicit and implicit incentives are substitutes rather than complements.

Keywords: moral hazard, bonus contract, implicit incentives, fairness, incentives
JEL Classification: C7, C9, J3
January 2007

Full text in pdf format:

197.pdf

A Soft Budget Constraint Explanation for the Venture Capital Cycle

Abstract:

We explore why venture capital funds limit the amount of capital they raise and do not reinvest the proceeds. This structure is puzzling because it leads to a succession of several funds financing each new venture which multiplies the well known agency problems. We argue that an inside investor cannot provide a hard budget constraint while a less well informed outsider can. Therefore, the venture capitalist delegates the continuation decision to the outsider by ex ante restricting the amount of capital he has under management. The soft budget constraint problem becomes the more important the higher the entrepreneur’s private benefits are and the higher the probability of failure of a project is.

Keywords: Contract Theory, Corporate Finance, Venture Capital
JEL Classification: G24, G31, D82
October 2006

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173.pdf

Exclusive vs Overlapping Viewers in Media Markets

Abstract:

This paper investigates competition for advertisers in media markets when viewers can subscribe to multiple channels. A central feature of the model is that channels are monopolists in selling advertising opportunities toward their exclusive viewers, but they can only obtain a competitive price for advertising opportunities to multi-homing viewers. Strategic incentives of firms in this setting are different than those in former models of media markets. If viewers can only watch one channel, then firms compete for marginal consumers by reducing the amount of advertising on their channels. In our model, channels have an incentive to increase levels of advertising, in order to reduce the overlap in viewership. We take an account of the differences between the predictions of the two types of models and find that our model is more consistent with recent developments in broadcasting markets. We also show that if channels can charge subscription fees on viewers, then symmetric firms can end up in an asymmetric equilibrium in which one collects all or most of its revenues from advertisers, while the other channel collects most of its revenues via viewer fees.

August 2006

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161.pdf

The Intensity of Incentives in Firms and Markets: Moral Hazard with Envious Agents

Abstract:

While most market transactions are subject to strong incentives, transactions within Firms are often not incentivized. We offer an explanation for this observation based on envy among agents in an otherwise standard moral hazard model with multiple agents. Envious agents suffer if other agents receive a higher wage due to random shocks to their performance measures. The necessary compensation for expected envy renders incentive provision more expensive, which generates a tendency towards flat-wage contracts. Moreover, empirical evidence suggests that social comparisons like envy are more pronounced among employees within Firms than among individuals who interact only in the market. Flat-wage contracts are thus more likely to be optimal in Firms than in markets.

Keywords: Envy, moral hazard, flat-wage contracts, within-Firm vs. market interactions
JEL Classification: D82, J3, M5
April 2006

Full text in pdf format:

115.pdf

Conditional Allocation of Control Rights in Venture Capital Finance

Abstract:

When a young entrepreneurial firm matures, it is often necessary to replace the founding entrepreneur by a professional manager. This replacement decision can be affected by the private benefits of control enjoyed by the entrepreneur which gives rise to a conflict of interest between the entrepreneur and the venture capitalist. We show that a combination of convertible securities and contingent control rights can be used to resolve this conflict efficiently. This contractual arrangement is frequently observed in venture capital finance.

Keywords: Corporate Finance, Venture Capital, Control Rights, Convertible Securities
JEL Classification: D23, G24, G32
February 2006

Full text in pdf format:

102.pdf

An Economic Approach to Article 82 - Report by the European Advisory Group on Competition Policy

Abstract:

This report argues in favour of an economics-based approach to Article 82, in a way similar to the reform of Article 81 and merger control. In particular, we support an effects-based rather than a form-based approach to competition policy. Such an approach focuses on the presence of anti-competitive effects that harm consumers, and is based on the examination of each specific case, based on sound economics and grounded on facts.

Keywords: Competition Policy, Abuse of Market Power, Article 82
JEL Classification: D4
July 2005

Full text in pdf format:

82.pdf

Fairness and Contract Design

Abstract:

We show experimentally that fairness concerns may have a decisive impact on the actual and optimal choice of contracts in a moral hazard context. Bonus contracts that offer a voluntary and unenforceable bonus for satisfactory performance provide powerful incentives and are superior to explicit incentive contracts when there are some fair-minded players. But trust contracts that pay a generous wage upfront are less efficient than incentive contracts. The principals understand this and predominantly choose the bonus contracts. Our results are consistent with recently developed theories of fairness, which offer important new insights into the interaction of contract choices, fairness and incentives.

Keywords: Moral Hazard, Incentives, Bonus Contract, Trust Contract, Fairness, Inequity Aversion
JEL Classification: C7, C9, J3
November 2005

Full text in pdf format:

67.pdf

The Economics of Fairness, Reciprocity and Altruism – Experimental Evidence and New Theories

Abstract:

Chapter written for the Handbook of Reciprocity, Gift-Giving and Altruism

Keywords: Behavioural Economics, Other-regarding Preferences, Fairness, Reciprocity, Altruism, Experiments, Incentives, Contracts, Competition
JEL Classification: C7, C9, D0, J3
June 2005

Full text in pdf format:

66.pdf

Fairness, Adverse Selection, and Employment Contracts

Abstract:

This paper considers a firm whose potential employees have private information on both their productivity and the extent of their fairness concerns. Fairness is modelled as inequity aversion, where fair-minded workers suffer if their colleagues get more income net of production costs. Screening workers with equal productivity but different fairness concerns is shown to be impossible if both types are to be employed, thereby rendering the optimal employment contracts discontinuous in the fraction of fair-minded workers. As a result, fairness might influence the employment contracts of all workers although only some are fair-minded, and identical firms facing very similar pools of workers might employ very different remuneration schemes.

Keywords: Fairness, Employment Contracts, Adverse Selection, Screening, Heterogeneity in Organizational Form
JEL Classification: C70, D21, D42, D63, D82, J31
July 2005

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58.pdf

Bargaining under Incomplete Information, Fairness, and the Hold-Up Problem

Abstract:

In the hold-up problem incomplete contracts cause the proceeds of relation-specific investments to be allocated by ex-post bargaining. The present paper investigates the efficiency of incomplete contracts if individuals have heterogeneous preferences implying heterogeneous bargaining behavior and - equally important - preferences are private information. As the sunk investment costs can thus potentially signal preferences, they can influence beliefs and consequently bargaining outcomes. The necessities of signalling are shown to generate very strong investment incentives. These incentives are based on the desire not to reveal information that is unfavorable in the ensuing bargaining. After finding all perfect Bayesian equilibria in pure strategies, the paper derives the necessary and sufficient conditions under which it is optimal to invest and trade efficiently.

Keywords: Incomplete Contracts, Hold-Up, Fairness, Bargaining under Incomplete Information, Signalling
JEL Classification: C70, D23, D63, D82, J33, K12, L22
February 2005

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57.pdf

Housing Market Dynamics: On the Contribution of Income Shocks and Credit Constraint

Abstract:

We propose a life-cycle model of the housing market with a property ladder and a credit constraint. We focus on equilibria which replicate the facts that credit constraints delay some households' first home purchase and force other households to buy a home smaller than they would like. The model helps us identify a powerful driver of the housing market: the ability of young households to afford the down payment on a starter home, and in particular their income. The model also highlights a channel whereby changes in income may yield housing price overshooting, with prices of trade-up homes displaying the most volatility, and a positive correlation between housing prices and transactions. This channel relies on the capital gains or losses on starter homes incurred by credit-constrained owners. We provide empirical support for our arguments with evidence from both the U.K. and the U.S.

Keywords: Housing Demand, Income Fluctuations, Overlapping Generations, Collateral Constraint
JEL Classification: E32, G12, G21, R21
May 2005

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50.pdf

Heterogeneity within Communities: A Stochastic Model with Tenure Choice

Abstract:

Standard explanations for the income heterogeneity within neighborhoods rely on differences of preferences across households and heterogeneity of the housing stock. We propose an alternative and complementary explanation. We construct a stochastic equilibrium sorting model where (1) income is the sole dimension of household heterogeneity, (2) households form state-contingent housing location plans that may involve moves over their lifetimes, (3) households choose whether to own or rent depending on the housing expenditure risk associated with each tenure mode, and (4) there is a probability that newcomer households move in and compete for homes with native households. Income mixing within neighborhood arises for two reasons. First, allowing natives to form state-contingent housing location plans breaks the indivisibility of housing consumption implicit in the literature where households choose their location once and for all. Second, natives can insure themselves against rent fluctuations by buying their home prior to the realization of the population shock; newcomers cannot. As a result, poorer natives stay in the more desirable communities and only richer newcomers move in these communities. Evidence from U.S. metropolitan areas supports the effects predicted by the model.

Keywords: Equilibrium Sorting, Income Mixing, Housing Demand, Tenure Choice
JEL Classification: D31, R12, R21
May 2005

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49.pdf

The Role of Equality and Efficiency in Social Preferences

Abstract:

Engelmann and Strobel (AER 2004) claim that a combination of efficiency seeking and minmax preferences dominates inequity aversion in simple dictator games. This result relies on a strong subject pool effect. The participants of their experiments were undergraduate students of economics and business administration who self-selected into their field of study and learned early on that efficiency is desirable. We show that for non-economists the preference for efficiency is much less pronounced. We also find a gender effect indicating that women are more egalitarian than men. However, perhaps surprisingly, the dominance of equality over efficiency is unrelated to political attitudes.

Keywords: Social Preferences, Inequity Aversion, Efficiency Preferences
JEL Classification: C7, C91, C92, D63, D64
October 2004

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30.pdf

Fairness and the Optimal Allocation of Ownership Rights

Abstract:

Lecture on the first SFB/TR 15 meeting, Gummersbach, July, 18 - 20, 2004

We report on several experiments on the optimal allocation of ownership rights. The experiments confirm the property rights approach by showing that the ownership structure affects relationship-specific investments and that the subjects achieve the most efficient ownership allocation starting from different initial conditions. However, in contrast to the property rights approach, the most efficient ownership structure is joint ownership. These results are neither consistent with the self-interest model nor with models that assume that all people behave fairly, but they can be explained by the theory of inequity aversion that focuses on the interaction between selfish and fair players.

Keywords: Ownership Rights, Double Moral Hazard, Fairness, Reciprocity, Incomplete Contracts
JEL Classification: C7, C9, J3
July 2004

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11.pdf