Balance of power and the propensity of conflict

Abstract:

We study the role of an imbalance in fighting strengths when players bargain in the shadow of conflict. Our experimental results suggest: In a simple bargaining game with an exogenous mediation proposal, the likelihood of conflict is independent of the balance of power. If bargaining involves endogenous demand choices, however, the likelihood of conflict is higher if power is more imbalanced. Even though endogenous bargaining outcomes reflect the players’ unequal fighting strengths, strategic uncertainty causes outcomes to be most efficient when power is balanced. In turn, the importance of exogenous mediation proposals depends on the balance of power.

JEL Classification: C78, C91, D72, D74

Keywords: Conflict, balance of power, contest, bargaining, Nash demand game, conflict resolution, asymmetries, experiment

Full text in pdf format:

528.pdf

A Theory of Crowdfunding - a mechanism design approach with demand uncertainty and moral hazard

Abstract:

Crowdfunding provides the innovation that, before the investment, entrepreneurs contract with consumers. Under demand uncertainty, this improves a screening for valuable projects. Entrepreneurial moral hazard threatens this benefit. Focusing on the trade-off between value screening and moral hazard, the paper characterizes optimal mechanisms. Current crowdfunding schemes reflect their salient features. Efficiency is sustainable only if returns exceed investment costs by a margin reflecting the degree of moral hazard. Constrained efficient mechanisms exhibit underinvestment. Crowdfunding blurs the distinction between finance and marketing, but complements rather than substitutes traditional entrepreneurial financing. As a screening tool for valuable projects, crowdfunding unambiguously promotes social welfare.

Keywords: Crowdfunding, finance, marketing, demand, uncertainty, moral hazard

Full text in pdf format:

527.pdf

Delegation and Communication

Abstract:

This paper analyzes delegation and joint decision making in an environment with private information and partially aligned preferences. We compare the benefits of these two decision making procedures as well as the interaction between them. We give a condition under which delegation is preferred to ex post joint decision making and we show how the interaction between delegation and ex post joint decision making always crowds out delegation. Finally, we analyze how the availability of the principal at the communication stage affects our results.

JEL classification: D23, D82, L23

Full text in pdf format:

524SFB.pdf

Undiscounted Bandit Games

Abstract:

We analyze continuous-time games of strategic experimentation with two-armedbandits when there is no discounting. We show that for all specifications of priorbeliefs and payoff-generating processes that satisfy some separability condition, the unique symmetric Markov perfect equilibrium can be computed in a simple closed form involving only the expected current payoff of the risky arm and the expected full-information payoff, given current information. The separability condition holds in a variety of models that have been explored in the literature, all of which assume that the risky arm’s expected payoff per unit of time is time-invariant and actual payoffs are generated by a process with independent and stationary increments. The separability condition does not hold when the expected payoff per unit of time is subject to state-switching.

JEL classification: C73, D83
Keywords: Strategic Experimentation, Two-Armed Bandit, Markov-Perfect Equilibrium

Full text in pdf format:

520c.pdf

Repeated Implementation

Abstract:

We prove that a social choice function is repeatedly implementable if and only if it is dynamically monotonic when the number of agents is at least three. We show how to test dynamic monotonicity by building an associated repeated game. It follows that a weaker version of Maskin monotonicity is necessary and sufficient among the social choice functions that are efficient. As an application, we show that utilitarian social choice functions, which can only be one-shot implemented with side-payments, are repeatedly implementable, as continuation payoffs can play the role of transfers. Under some additional assumptions, our results also apply when the number of agents is two.

JEL classification: C73, D71
Keywords: Mechanism Design, Dynamic Monotonicity, Efficiency, Repeated Implementation, Repeated Games, Approximation of the Equilibrium Set, Sufficient and Necessary Condition

Full text in pdf format:

518SFB.pdf

Believing when Credible: Talking about Future Plans and Past Actions

Abstract:

We explore in an equilibrium framework whether games with multiple Nash equilibria are easier to play when players can communicate. We consider two variants, modelling talk about future plans and talk about past actions. The language from which messages are chosen is endogenous, messages are allowed to be vague. We focus on equilibria where messages are believed whenever possible, thereby develop a theory of credible communication. Predictions confirm the longstanding intuition for Aumann’s (1990) Stag Hunt game which applies directly to an investment game with positive spillovers. Our results shed new light on the multiplicity of equilibria in economic applications.

JEL classification: C72, D83
Keywords: Pre-Play Communication, Cheap Talk, Credibility, Coordination, Language, Multiple Equilibria.

Full text in pdf format:

517SFB.pdf

Democratic Redistribution and Rule of the Majority

Abstract:

Does redistribution in democracies cater to the will of the majority? We propose a direct empirical strategy based on survey data that needs not assume that voters are guided by pecuniary motives alone. We find that most democracies implement the median voter’s preferred amount of redistribution and the probability to serve the median voter increases with the quality of democracy. However, there is a non-negligible share of democracies that implement a minority-backed amount of redistribution. Political absenteeism of the poor cannot explain such outcomes. Rather, they can be explained by the electoral bundling of redistribution with values and rights issues.

JEL classification: D3, D7, H1, P16
Keywords: Redistribution, Democracy, Median-voter theorem, Inequality

Full text in pdf format:

514_01.pdf

Licensing Innovations: The Case of the Inside Patent Holder

Abstract:

The present paper reconsiders the inside innovators’ licensing problem under incomplete information. Employing an optimal mechanism design approach, we show that, contrary to what is claimed in the literature, the optimal mechanism may prescribe fixed fees, royalty rates lower than the cost reduction, and even negative royalty rates.

Keywords: Innovation, licensing, industrial organization.

JEL Classification: D21, D43, D44, D45

Full text in pdf format:

510.pdf

Mediated Audits

Abstract:

I study the optimal audit mechanism when the principal cannot commit to an audit strategy. Invoking a revelation principle, the agent reports her type to a mediator who assigns contracts and recommends the principal whether to audit. For each reported type the mediator randomizes over a base-contract and the audit contract, accompanied by a recommendation to audit. For large penalties the optimal mechanism uses strictly more contracts than types and cannot be implemented via offering a menu of contracts. The analysis provides a proper benchmark for studying auditing under limited commitment and sheds new light on the usefulness of mediation in contracting and on the design of optimal mechanisms.

JEL classification: D82, D86, C72
Keywords: Auditing, limited commitment, mediation, contract theory

Full text in pdf format:

509.pdf

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

Parental background matters: Intergenerational mobility and assimilation of Italian immigrants in Germany

Abstract:

We investigate the hypothesis of failed integration and low social mobility of immigrants. An intergenerational assimilation model is tested empirically on household survey data and validated against administrative data provided us by the Italian Embassy in Germany. Although we confirm substantial inequality of educational achievements between immigrants and natives, we find that the children of Italian immigrants exhibit high intergenerational mobility and no less opportunities than natives to achieve high schooling degrees. These findings suggest a rejection of the failed assimilation hypothesis. Additionally, we evaluate different patterns by time of arrival, Italian region of origin and language spoken at home.

Keywords: Intergenerational Mobility; Education; Integration and Assimilation of Immigrants.

JEL Classification: I24, J15, J62.

Full text in pdf format:

502.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

Who goes first? Strategic Delay and Learning by Waiting

Abstract:

This paper considers a "war of attrition" game in which agents learn about an uncertain state of the world through private signals and from their peers. I provide existence and uniqueness results for a class of equilibria that satisfy a \full-participation" condition, and show that asymmetries in the distribution of information can lead to excessive stopping and an oversupply of information relative to the social optimum.

Full text in pdf format:

500.pdf

Pricing a Package of Services - When (not) to bundle

Abstract:

We study a tractable two-dimensional model of price discrimination. Consumers combine a rigid with a more flexible choice, such as choosing the location of a house and its quality or size. We show that the optimal pricing scheme involves no bundling if consumer types are affiliated. Conversely, if consumer types are negatively affiliated over some portion of types then some bundling occurs.

JEL classification: D42, D82, D86

Keywords: Price discrimination, Bundling, Monopoly, Multidimensional screening

Full text in pdf format:

487.pdf

Managerial Incentive Problems and Return Distributions

Abstract:

We study a model of managerial incentive problems where a manager chooses the first two moments of his firm’s profit distribution - mean and volatility - along an efficient frontier. Assuming that managers differ with respect to their marginal cost of effort and their risk aversion we explore our model’s comparative statics predictions in full detail. If managers’ preference parameters are commonly known and associated, then a positive correlation between expected returns, volatility of profits, and incentives is the natural outcome. Allowing in addition for adverse selection with respect to the managers’ preference parameters does not change the predicted correlation if the variation in observed contracts is not too large. Moreover, observed incentive schemes reflect exclusion of some manager types. Neglecting the endogeneity of risk in empirical studies biases estimates towards zero.

JEL Classification: D82, J33

Keywords: Managerial incentive problems, comparative statics, multidimensional heterogeneity, multidimensional screening

Full text in pdf format:

486.pdf

Learning faster or more precisely? Strategic experimentation in networks

Abstract:

The paper analyzes a dynamic model of rational strategic learning in a network. It complements existing literature by providing a detailed picture of short-run dynamics in a game of strategic experimentation where agents are located in a social network. We show that the delay in information transmission caused by incomplete network structures may induce players to increase own experimentation efforts. As a consequence a complete network can fail to be optimal even if there are no costs for links. This means that in the design of networks there exists a trade-off between the speed of learning and accuracy.

Key Words: Strategic Experimentation, Networks, Learning

JEL codes: C73, D83, D85

Full text in pdf format:

485.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

Credence Goods, Costly Diagnosis, and Subjective Evaluation

Abstract:

We study contracting between a consumer and an expert. The expert can invest in diagnosis to obtain a noisy signal about whether a low–cost service is sufficient or whether a high–cost treatment is required to solve the consumer’s problem. This involves moral hazard because diagnosis effort and signals are not observable. Treatments are contractible, but success or failure of the low–cost treatment is observed only by the consumer. Payments can therefore not depend on the objective outcome but only the consumer’s report, or subjective evaluation. A failure of the low–cost treatment delays the solution of the consumer’s problem by the high–cost treatment to a second period. We show that the first–best solution can always be implemented if the parties’ discount rate is zero; an increase in the discount rate reduces the range of parameter combinations for which the first–best can be obtained. In an extension we show that the first–best is also always implementable if diagnosis and treatment can be separated by contracting with two different agents.

Keywords: credence goods, information acquisition, moral hazard, subjective evaluation
JEL Classification No.: D82, D83, D86, I11,

Full text in pdf format:

483_01.pdf

Informational opacity and honest certification

Abstract:

This paper studies the interaction of information disclosure and reputational concerns in certification markets. We argue that by revealing less precise information a certifier reduces the threat of capture. Opaque disclosure rules may reduce profits but also constrain feasible bribes. For large discount factors a certifier is unconstrained in the choice of a disclosure rule and full disclosure maximizes profits. For intermediate discount factors, only less precise, such as noisy, disclosure rules are implementable. Our results suggest that contrary to the common view, coarse disclosure may be socially desirable. A ban may provoke market failure especially in industries where certifier reputational rents are low.

Keywords: Certification; Bribery; Reputation

JEL Classification Numbers: L15; D82; L14; L11

Full text in pdf format:

481.pdf

Optimal incentive contracts to avert firm relocation

Abstract:

A unilateral policy intervention by a country (such as the introduction of an emission price) can induce firms to relocate to other countries. We analyze a dynamic game where a regulator offers contracts to avert relocation of a firm in each of two periods. The firm can undertake a location-specific investment (e.g., in abatement capital). Contracts can be written on some contractible productive activity (e.g., emissions), but the firm's investment is not contractible. A moral hazard problem arises under short-term contracting that makes it impossible to implement outcomes with positive transfers in the second period. The regulator resorts to high-powered incentives in the first period. The firm then overinvests and a lock-in effect prevents relocation in both periods. Paradoxically, the distortion in the firstperiod contract can be so severe that higher transfers are needed to avert relocation compared to a (hypothetical) situation without the investment opportunity.

Keywords: moral hazard; contract theory; limited commitment; firm mobility; abatement capital

JEL classification: D82, D86, L51, Q58

Full text in pdf format:

480.pdf

Smooth, strategic communication

Abstract:

We study strategic information transmission in a Sender-Receiver game where players' optimal actions depend on the realization of multiple signals but the players disagree on the relative importance of each piece of news. We characterize a statistical environment - featuring symmetric loss functions and elliptically distributed parameters - in which the Sender's expected utility depends only on the first moment of his posterior. Despite disagreement about the use of underlying signals, we demonstrate the existence of equilibria in differentiable strategies in which the Sender can credibly communicate posterior means. The existence of smooth communication equilibria depends on the relative usefulness of the signal structure to Sender and Receiver, respectively. We characterize extensive forms in which the quality of information is optimally designed of equal importance to Sender and Receiver so that the best equilibrium in terms of ex ante expected payoffs is a smooth communication equilibrium. The quality of smooth equilibrium communication is entirely determined by the correlation of interests. Senders with better aligned preferences are endogenously endowed with better information and therefore give more accurate advice.

Keywords: strategic information transmission, multi-dimensional cheap talk, monotone strategies, endogenous information, elliptical distributions

JEL: D82

Full text in pdf format:

479.pdf

The Merger-Paradox: A Tournament-Based Solution

Abstract:

According to the well-known “merger paradox”, in a Cournot market game mergers are generally unprofitable unless most firms merge. The present paper proposes an optimal merger mechanism. With this mechanism mergers are never unprofitable, more profitable than in other known mechanism, and in many cases welfare increasing. The proposed mechanism assumes that merged firms continue to operate as independent subsidiaries that are rewarded according to a simple and commonly observed relative performance measure.

Keywords: Mergers, multi-divisional firms, tournaments, industrial organization.

JEL Classifications: L00, D4

Full text in pdf format:

478.pdf

Strongly Symmetric Equilibria in Bandit Games

Abstract:

This paper studies strongly symmetric equilibria (SSE) in continuous-time games of strategic experimentation with Poisson bandits. SSE payoffs can be studied via two functional equations similar to the HJB equation used for Markov equilibria. This is valuable for three reasons. First, these equations retain the tractability of Markov equilibrium, while allowing for punishments and rewards: the best and worst equilibrium payoff are explicitly solved for. Second, they capture behavior of the discrete-time game: as the period length goes to zero in the discretized game, the SSE payoff set converges to their solution. Third, they encompass a large payoff set: there is no perfect Bayesian equilibrium in the discrete-time game with frequent interactions with higher asymptotic efficiency.

Keywords: Two-Armed Bandit, Bayesian Learning, Strategic Experimentation,

Strongly Symmetric Equilibrium.

JEL Classification Numbers: C73, D83.

Full text in pdf format:

469.pdf

Optimal bid disclosure in license auctions with downstream interaction

Abstract:

The literature on license auctions for process innovations in oligopoly assumed that the auctioneer reveals the winning bid and stressed that this gives firms an incentive to signal strength through their bids, to the benefit of the innovator. In the present paper we examine whether revealing the winning bid is optimal. We consider three disclosure rules: full, partial, and no disclosure of bids, which correspond to standard auctions. We show that more information disclosure increases the total surplus divided between firms and the innovator as well as social surplus. More disclosure also increases bidders’ payoff. However, no disclosure maximizes the innovator’s expected revenue.

Keywords: Auctions, innovation, licensing, information sharing.

JEL Classifications: D21, D43, D44, D45

Full text in pdf format:

467.pdf

Mergers between regulated firms with unknown efficiency gains

Abstract:

In an industry where regulated firms interact with unregulated suppliers, we investigate the welfare effects of a merger between regulated firms when efficiency gains are uncertain before the merger and their realization becomes private information of the merged firm. The optimal merger policy trades off potential efficiency gains against regulatory distortions from informational problems. We show that, as a consequence of this trade-off, more intense competition in unregulated segments of the market induces a more lenient merger policy. However, the regulated firms' diversification into a competitive segment can lead to a more lenient merger policy when competition is weaker.

Keywords: asymmetric information, competition, efficiency gains, mergers, regulation.

JEL Classification: D82, L43, L51.

Full text in pdf format:

464_01.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

Signaling Competence in Elections

Abstract:

We analyze how political candidates can signal their competence and show that polarization might be a way of doing this. For this purpose, we study a unidimensional Hotelling-Downs model of electoral competition in which a fraction of candidates have the ability to correctly observe a policy-relevant state of the world. We show that candidates tend to polarize, even in the absence of policy bias. This is because proposing an extreme platform has a competence signaling effect and has a strictly higher probability of winning than proposing a median platform. The degree of polarization depends on how uncertain is the state of the world.

Full text in pdf format:

442.pdf

Commitments, Intentions, Truth and Nash Equilibria

Abstract:

Games with multiple Nash equilibria are believed to be easier to play if players can communicate. We present a simple model of communication in games and investigate the importance of when communication takes place. Sending a message before play captures talk about intentions, after play captures talk about past commitments. We focus on equilibria where messages are believed whenever possible. Applying our results to Aumann’s Stag Hunt game we find that communication is useless if talk is about commitments, while the efficient outcome is selected if talk is about intentions. This confirms intuition and empirical findings in the literature.

We develop a theory of credible communication under complete information and connect it to the notion of credibility in standard senderreceiver games.

Keywords: Pre-play communication, cheap talk, credibility, coordination, sender-receiver games.

JEL Classification Numbers: C72, D83.

Full text in pdf format:

438.pdf

Mechanism Design by an Informed Principal: The Quasi- Linear Private-Values Case

Abstract:

We show that, in environments with independent private values and transferable utility, a privately informed principal can implement a contract that is ex-ante  optimal for her. As an application, we consider a bilateral exchange environment (Myerson and Satterthwaite, 1983) in which the principal is one of the traders. If the property rights over the good are dispersed among the traders, the principal will implement a contract in which she is almost surely better off than if there were no uncertainty about her information. The optimal contract is a combination of a participation fee, a buyout option for the principal, and a resale stage with posted prices and, hence, is a generalization of the posted price that would be optimal if the principal's valuation were commonly known. We also provide a condition under which the principal implements the same contract regardless of whether the agents know her information or not.

Full text in pdf format:

437.pdf

Objective versus Subjective Performance Evaluations

Abstract:

Why does incentive pay often depend on subjective rather than objective performance evaluations? After all, subjective evaluations entail a credibility issue. While the most plausible explanation for this practice is lack of adequate objective measures, I argue that subjective evaluations might sometimes also be used to withhold information from the worker. I furthermore argue that withholding information is particularly important under circumstances where the credibility issue is small. The statements are derived from a two-stage principal-agent model in which the stochastic relationship between effort and performance is unknown.

Keywords: Performance evaluation, principal-agent, moral hazard

JEL Codes: D83, D86, M12, M52

Full text in pdf format:

430.pdf

Precontractual Investigation and Sequential Screening

Abstract:

Should contract design induce an agent to conduct a precontractual investigation even though, in any case, the agent will become fully informed after the signing of the contract? This paper shows that imperfect investigations might be encouraged. The result stands in contrast to previous studies, which focus on perfect investigations. The contrast exists because if precontractual investigation is perfect, the benefits of sequential screening vanish.

Keywords: Principal agent, information acquisition, sequential screening

JEL Codes: D82, D83, D86

Full text in pdf format:

429.pdf

Acquisition and Disclosure of Information as a Hold-up Problem

Abstract:

The acquisition of information prior to sale gives rise to a hold-up situation quite naturally. Yet, while the bulk of the literature on the hold-up problem considers negotiations under symmetric information where cooperative short-cuts such as split the difference capture the outcome of bargaining, in the present setting, parties negotiate under asymmetric information where the outcome must be derived from a non-cooperative bargaining procedure. To avoid the difficult task of specifying and solving complicated games combining elements of signalling and screening, but to still compare incentives for acquiring information under voluntary versus mandatory disclosure, use of conditions such as incentive, disclosure and participation constraints only is made that are common to all non-cooperative bargaining outcomes.

JEL classification: K12, K13

Keywords: mistake, information acquisition, disclosing information

Full text in pdf format:

428.pdf

Optimal Sequential Delegation

Abstract:

The paper extends the optimal delegation framework pioneered by Holmström (1977, 1984) to a dynamic environment where, at the outset, the agent privately knows his ability to interpret decision relevant private information received later on. We show that any mechanism can be implemented by a sequential menu of delegation sets where the agent first picks a delegation set and then chooses an action within this set. For the uniform{quadratic case, we characterize when sequential delegation is strictly better than static delegation and derive the optimal delegation menu. We provide sufficient conditions so that our results extend beyond the uniform distribution.

Keywords: optimal delegation, sequential screening, dynamic mechanism design,

non-transferable utility.

JEL Codes: D02, D20, D82, D86.

Full text in pdf format:

427.pdf

Fight Alone or Together? The Need to Belong

Abstract:

Alliances often face both free-riding and hold-up problems, which under- mine the effectiveness of alliances in mobilizing joint fighting effort. Despite of these disadvantages, alliances are still ubiquitous in all types of contests. This paper asks if there are non-monetary incentives to form alliances, e.g., intimidating/discouraging the single player(s) who is/are left alone. For this purpose, I compare symmetric (2 vs. 2) and asymmetric (2 vs. 1) contests to their equivalent 4-player and 3-player individual contests, respectively. We find that alliance players in symmetric (2 vs. 2) contests behave the same as those in equivalent 4-player individual contests. However, in asymmetric (2 vs. 1) contests, stand-alone players were strongly discouraged to exert effort (especially the females), compared to the 3-player individual contests. Alliance players may have anticipated this effect and also reduced their effort, if alliances share the prize according to the merit rule. Behavioural factors such as the need to belong can help reconcile the "paradox of alliance formation".

Keywords: Alliance Formation, Contest and Conflict, Experiment.

JEL Codes: D72; D74; C91

Full text in pdf format:

421.pdf

Alliances in the Shadow of Con‡flict

Abstract:

Victorious alliances often fight about the spoils of war. This paper presents an experiment on the determinants of whether alliances break up and fight internally after having defeated a joint enemy. First, if peaceful sharing yields an asymmetric rent distribution, this increases the likelihood of fighting. In turn, anticipation of the higher likelihood of internal fight reduces the alliance’s ability to succeed against the outside enemy. Second, the option to make non-binding declarations on non-aggression in the relationship between alliance members does not make peaceful settlement within the alliance more likely. Third, higher differences in the alliance players’ contributions to alliance effort lead to more internal conflict and more intense fighting.

Keywords: Conflict; Contest; Alliance; Endogenous internal conflict; Hold-up problem; Non-aggression pact; Experiment

JEL Codes: D72; D74

Full text in pdf format:

420.pdf

Endogenous group formation in experimental contests

Abstract:

We study endogenous group formation in tournaments employing experimental three-player contests. We find that players in endogenously formed alliances cope better with the moral hazard problem in groups than players who are forced into an alliance. Also, players who are committed to expending effort above average choose to stand alone. If these players are forced to play in an alliance, they invest even more, whereas their co-players choose lower effort. Anticipation of this exploitation may explain their preference to stand alone.

Keywords: Endogenous group formation, contest, conflict, alliance, experiment, moral hazard problem, free-riding, in-group favoritism

JEL codes: D72, D74

Full text in pdf format:

419.pdf

Evolutionary determinants of war

Abstract:

This paper considers evolutionarily stable decisions about whether to initiate violent conflict rather than accepting a peaceful sharing outcome. Focusing on small sets of players such as countries in a geographically confined area, we use Schaffer’s (1988) concept of evolutionary stability. We find that players ‘evolutionarily stable preferences widen the range of peaceful resource allocations that are rejected in favor of violent conflict, compared to the Nash equilibrium outcomes. Relative advantages in fighting strength are reflected in the equilibrium set of peaceful resource allocations.

Keywords: Conflict; Contest; Endogenous fighting; Balance of power; Evolutionary stability

JEL Codes: D72; D74

Full text in pdf format:

418.pdf

Optimal Voting Rules

Abstract:

We study dominant strategy incentive compatible (DIC) and deterministic mechanisms in a social choice setting with several alternatives. The agents are privately informed about their preferences, and have single-crossing utility functions. Monetary transfers are not feasible. We use an equivalence between deterministic, DIC mechanisms and generalized median voter schemes to construct the constrained-efficient, optimal mechanism for an utilitarian planner. Optimal schemes for other welfare criteria such as, say, a Rawlsian maximin can be analogously obtained.

Full text in pdf format:

417.pdf

Ex post information rents and disclosure in sequential screening

Abstract:

We study ex post information rents in sequential screening models where the agent receives private ex ante and ex post information. The principal has to pay ex post information rents for preventing the agent to coordinate lies about his ex ante and ex post information. When the agent’s ex ante information is discrete, these rents are positive, whereas they are zero in continuous models. Consequently, full disclosure of ex post information is generally suboptimal. Optimal disclosure rules trade off the benefits from adapting the allocation to better information against the effect that more information aggravates truth-telling.

Keywords: information rents, sequential screening, information disclosure

JEL codes: D82, H57

Full text in pdf format:

406.pdf

Work Norms, Social Insurance and the Allocation of Talent

Abstract:

This paper challanges the view that weak work norms in generous welfare states makes them economically unsustainable. I develop a dynamic model of family-transmitted values that has a laissez-faire equilibrium with strong work norms coexisting with a social-insurance equilibrium with weak work norms. While the former has better incentives, the latter induces more intergenerational occupational mobility which improves the allocation of talent and fuels growth. Strong work norms arise as a defensive strategy of parents that aims at perpetuating their occupation along family lines. I present evidence from microdata showing that generous social insurance correlates with high intergenerational occupational mobility and that more mobile individuals endorse weaker work norms.

Keywords: work norms, unemployment insurance, occupational mobility, economic growth.

JEL-Classification: H2, O0, Z1.

Full text in pdf format:

405_01.pdf

Auctions with imperfect commitment when the reserve may serve as a signal

Abstract:

If bidders are uncertain whether the auctioneer sticks to the announced reserve, some bidders respond by not bidding, speculating that the auctioneer may revoke the reserve. However, the reserve inadvertently signals the auctioneer's type, which drives a unique separating and a multitude of pooling equilibria. If one eliminates belief systems that violate the "intuitive criterion'', one obtains a unique equilibrium reserve price equal to the seller's own valuation. Paradoxically, even if bidders initially believe that the auctioneer is bound by his reserve almost with certainty, commitment has no value.

Keywords: Auctions, signalling, mechanism design.

JEL Classifications: D21, D43, D44, D45.

Full text in pdf format:

403_01.pdf

Exit Options and the Allocation of Authority

Abstract:

We analyze the optimal allocation of authority in an organization whose members have conflicting preferences. One party has decision-relevant private information, and the party who obtains authority decides in a self-interested way. As a novel element in the literature on decision rights, we consider exit option contracts: the party without decision rights is entitled to prematurely terminate the relation after the other party's choice. We show that under such a contract it is always optimal to assign authority to the informed and not to the uninformed party, irrespective of the parties' conflict of interest. Indeed, the first-best efficient solution can be obtained by such a contract.

Keywords: Authority, decision rights, exit options, incomplete contracts, asymmetric information.

JEL Classification No.: D23, D82, D86.

Full text in pdf format:

401.pdf

Signalling Rivalry and Quality Uncertainty in a Duopoly

Abstract:

This paper considers price competition in a duopoly with quality uncertainty. The established firm (the `incumbent') offers a quality that is publicly known; the other firm (the `entrant') offers a new good whose quality is not known by some consumers. The incumbent is fully informed about the entrant's quality. This leads to price signalling rivalry because the incumbent gains and the entrant loses if observed prices make the uninformed consumers more pessimistic about the entrant's quality. When the uninformed consumers' beliefs satisfy the `intuitive criterion' and the `unprejudiced belief refinement', prices signal the entrant's quality only in a two-sided separating equilibrium and are identical to the full information outcome.

Keywords: Quality uncertainty, Signalling, Oligopoly, Price competition

JEL Classification No.: D43, D82, L15

Full text in pdf format:

400_01.pdf

Subjective Evaluation versus Public Information

Abstract:

This paper studies a principal-agent relation in which the principal's private information about the agent's effort choice is more accurate than a noisy public performance measure. For some contingencies the optimal contract has to specify ex post inefficiencies in the form of inefficient termination (firing the agent) or third-party payments (money burning). We show that money burning is the less efficient incentive device: it is used at most in addition to firing and only if the loss from termination is small. Under an optimal contract the agent's wage may depend only on the principal's report and not on the public signal. Nonetheless, public information is valuable as it facilitates truthful subjective evaluation by the principal.

Keywords: Subjective evaluation, moral hazard, termination clauses, third-party payments

JEL Classification No.: D23, D82, D86, J41, M12

Full text in pdf format:

399.pdf

Regulating a multiproduct and multitype monopolist

Abstract:

I study the optimal regulation of a firm producing two goods. The firm has private information about its cost of producing either of the goods. I explore the ways in which the optimal allocation differs from its one dimensional counterpart. With binding constraints in both dimensions, the allocation involves distortions for the most efficient producers and features overproduction for some less efficient types.

JEL classification: D82, L21, Asymmetric Information, Multi-dimensional Screening, Regulation.

Full text in pdf format:

397.pdf

Breakdowns

Abstract:

We study a continuous-time game of strategic experimentation in which the players try to assess the failure rate of some new equipment or technology. Breakdowns occur at the jump times of a Poisson process whose unknown intensity is either high or low. In marked contrast to existing models, we find that the cooperative value function does not exhibit smooth pasting at the efficient cut-off belief. This finding extends to the boundaries between continuation and stopping regions in Markov perfect equilibria. We characterize the unique symmetric equilibrium, construct a class of asymmetric equilibria, and elucidate the impact of bad versus good Poisson news on equilibrium outcomes.

Keywords: Strategic Experimentation, Two-Armed Bandit, Bayesian Learning,
Poisson Process, Piecewise Deterministic Process, Markov Perfect Equilibrium,
Differential-Difference Equation, Smooth Pasting, Continuous Pasting.
JEL Classification Numbers: C73, D83, O32

Full text in pdf format:

396.pdf

Delays in Leniency Application: Is There Really a Race to the Enforcer’s Door?

Abstract:

This paper studies cartels’ strategic behavior in delaying leniency applications, a take-up decision that has been ignored in the previous literature. Using European Commission decisions issued over a 16-year span, we show, contrary to common beliefs and the existing literature, that conspirators often apply for leniency long after a cartel collapses. We estimate hazard and probit models to study the determinants of leniency-application delays. Statistical tests find that delays are symmetrically affected by antitrust policies and macroeconomic fluctuations. Our results shed light on the design of enforcement programs against cartels and other forms of conspiracy. Journal of Economic Literature

Classification Numbers: D43, K21, K42, L13.
Keywords: corporate leniency program, cartel, leniency application delays

Full text in pdf format:

395.pdf

License auctions with exit (and entry) options: Alternative remedies for the exposure problem

Abstract:

Inspired by some spectrum auctions, we consider a stylized license auction with incumbents and one entrant. Whereas the entrant values only the bundle of several units (synergy), incumbents are subject to non-increasing demand. The seller proactively encourages entry and restricts incumbent bidders. In this framework, an English clock auction gives rise to an exposure problem that distorts eciency and impairs revenue. We consider three remedies: a (constrained) Vickrey package auction, an English clock auction with exit option that allows the entrant to annul his bid, and an English clock auction with exit and entry option that lifts the bidding restriction if entry failed.

Keywords: Auctions, package auctions, combinatorial clock auctions,
spectrum auction, bundling, synergies.
2000 MSC: D21, D43, D44, D45G34.

Full text in pdf format:

394.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

Path-Dependent Behavior with Asymmetric Information about Traders' Types

Abstract:

We define path-dependency as the generic phenomenon according to which agents take an action regardless of their private information. Path-dependency can be of two types contingent on whether agents act with the crowd (herding) or against the crowd (contrarianism). We consider a quote-driven market where traders can in some cases observe whether their predecessors were informed, although they cannot  observe their private information, while in other cases they are left with the uncertainty that their predecessors acted purely for liquidity motives. In this setting we recover herding and contrarianism and we find that better-informed markets (i.e. where informed traders receive high precision signals) can generate path-dependent behavior more easily than poorly informed ones. Moreover, we illustrate how a market dominated by herding features a price that is more informative of the asset value than the price of a market where traders always follow their signal. We also discuss how contrarianism has the exact opposite effect by decreasing price informativeness.

JEL: D82, D83, G14

Keywords: Herding, Contrarianism, Financial Markets

Full text in pdf format:

388.pdf

Strategic Experimentation with Private Payoffs

Abstract:

We consider two players facing identical discrete-time bandit problems with a safe and a risky arm. In any period, the risky arm yields either a success or a failure, and the first success reveals the risky arm to dominate the safe one. When payoffs are public information, the ensuing free-rider problem is so severe that the equilibrium number of experiments is at most one plus the number of experiments that a single agent would perform. When payoffs are private information and players can communicate via cheap talk, the socially optimal symmetric experimentation profile can be supported as a perfect Bayesian equilibrium for sufficiently optimistic prior beliefs. These results generalize to more than two players whenever the success probability per period is not too high. In particular, this is the case when successes occur at the jump times of a Poisson process and the period length is sufficiently small.

JEL classification: C73, D83.

Keywords: Strategic Experimentation, Bayesian Learning, Cheap Talk, Two-Armed Bandit, Information Externality.

Full text in pdf format:

387.pdf

Strategic information transmission and stochastic orders

Abstract:

I develop new results on uniqueness and comparative statics of equilibria in the Crawford and Sobel (1982) strategic information transmission game. For a class of utility functions, I demonstrate that logconcavity of the density implies uniqueness of equilibria inducing a given number of Receiver actions. I provide comparative statics results with respect to the distribution of types for distributions that are comparable in the likelihood ratio order, implying, e.g., that advice from a better informed Sender induces the Receiver to choose actions that are more spread out.

Keywords: strategic information transmission, cheap talk, uniqueness, comparative statics, logconcavity, likelihood ratio order

JEL classification: D82

Full text in pdf format:

386.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

Income Inequality and Self-Reported Values

Abstract:

This paper offers a comprehensive econometric investigation of the impact of income inequality on the values endorsed by people. Using survey data from all thirty-four OECD countries over a period of almost thirty years, the following dimensions of value systems are investigated: work ethic, civism, obedience, honesty, altruism, and tolerance. In most cases, no robust effects from inequality on values are detected. However, there is evidence that a more unequal income distribution strengthens the work ethic of the population. Thus, income inequality seems to generate work incentives not only via the pecuniary reward of work but also through the symbolic reward it receives.

Keywords: Income inequality, Value systems.

JEL-Classification: D63, O15, O57, Z1

Full text in pdf format:

382.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

Optimal Use of Rewards as Commitment Device When Bidding is Costly

Abstract:

This paper considers procurement auctions with costly bidding when the  auctioneer is unable to commit himself to restrict the number of bidders. The auctioneer can, however, oer a nancial reward to be paid to every short-listed bidders as an indirect commitment device. Rewards for short-listed bidders are costly. Nevertheless, it is generally optimal for the procurer to credibly implement the same restriction of the number of bidders that is optimal under full commitment.
Keywords: Procurement, auctions, industrial organization, mechanism design.
JEL classification: D21, D43, D44, D45.

Full text in pdf format:

377.pdf

Continuous Time Contests

Abstract:

This paper introduces a contest model in which each player decides when to stop a privately observed Brownian motion with drift and incurs costs depending on his stopping time. The player who stops his process at the highest value wins a prize. Applications of the model include procurement contests and competitions for grants. We prove existence and uniqueness of the Nash equilibrium outcome, even if players have to choose bounded stopping times. We derive the equilibrium distribution in closed form. If the noise vanishes, the equilibrium outcome converges to - and thus selects - the symmetric equilibrium outcome of an all-pay auction. For two players and constant costs, each player’s profits increase if costs for both players increase, variance increases, or drift decreases. Intuitively, patience becomes a more important factor for contest success, which reduces informational rents.
Keywords: Contests, all-pay contests, silent timing games.

Full text in pdf format:

376.pdf

Gambling in Contests

Abstract:

This paper presents a strategic model of risk-taking behavior in contests. Formally, we analyze an n-player winner-take-all contest in which each player decides when to stop a privately observed Brownian Motion with drift. A player whose process reaches zero has to stop. The player with the highest stopping point wins. Contrary to the explicit cost for a higher stopping time in a war of attrition, here, higher stopping times are riskier, because players can go bankrupt. We derive a closed-form solution of the unique Nash equilibrium outcome of the game. In equilibrium, the trade-off between risk and reward causes a non-monotonicity: highest expected losses occur if the process decreases only slightly in expectation.
Keywords: Discontinuous games; Contests; Relative performance pay; Risktaking behavior
JEL classification: C72; C73; D81

Full text in pdf format:

375.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

Security bid auctions for agency contracts

Abstract:

A principal uses security bid auctions to award an incentive contract to one among several agents, in the presence of hidden action and hidden information. Securities range from cash to equity and call options. “Steeper” securities are better surplus extractors that narrow the gap between the two highest valuations, yet reduce effort incentives. In view of this trade-off, the generalized equity auction that includes a (possibly negative) cash reward to the winner tends to outperform all other auctions, although it cannot extract the entire surplus and implement efficient effort. Hence, profit sharing emerges without risk aversion or limited liability.
Keywords: Auctions, agency problems, licensing, innovation, mechanism design.
JEL classification: D21, D43, D44, D45.

Full text in pdf format:

371_02.pdf

Cartel Duration and Endogenous Private Monitoring and Communication: An Instrumental Variables Approach

Abstract:

Colluding firms often exchange private information and make transfers within the cartels based on the information. Estimating the impact of such collusive practices— known as the “lysine strategy profile (LSP)”— on cartel duration is difficult because of endogeneity and omitted variable bias. I use firms’ linguistic differences as an instrumental variable for the LSP in 135 cartels discovered by
the European Commission since 1980. The incidence of the LSP is not  significantly related to cartel duration. After correction for selectivity in the decision to use the LSP, statistical tests are consistent with a theoretic prediction that the LSP increases cartel duration.
Keywords: the lysine strategy profile, post-agreement information exchange, within-cartel transfers, monitoring, verification and promotion of compliance, cartel duration, endogenous covariates
JEL classification: D43, K21, K42, L13.

Full text in pdf format:

369.pdf

The Timing of Climate Agreements under Multiple Externalities

Abstract:

We study the potential of cooperation in global emission abatements with multiple externalities. Using a two-country model without side-payments, we identify the strategic effects under different timing regimes of cooperation. We obtain a positive complementarity effect of long-term cooperation in abatement on R&D levels that boosts potential benefit of long-term cooperation and a redistributive effect that destabilizes long-term cooperation when countries are asymmetric. We show that whether and what type of cooperation is sustainable, depends crucially on the kind rather than on the magnitude of asymmetries.

Keywords: climate treaty; timing of cooperation; multiple externalities; long-term commitment

JEL classification: D62, F53, H23, Q55

November 2011

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366.pdf

Experimentation in Two-Sided Markets

Abstract:

We study optimal experimentation by a monopolistic platform in a two-sided market framework. The platform provider faces uncertainty about the strength of the externality each side is exerting on the other. It maximizes the expected present value of its profit stream in a continuous-time infinite-horizon framework by setting participation fees or quantities on both sides. We show that a price-setting platform provider sets a fee lower than the myopically optimal level on at least one side of the market, and on both sides if the two externalities are of approximately equal strenght. If the externality that one side exerts is sufficiently weaker than the externality it experiences, the optimal fee on this side exceeds the myopically optimal level. We obtain analogous results for expected prives when the platform provider chooses quantities. While the optimal policy does not admin closed-form representations in general, we identify special cases in which the undiscounted limit of the model can be solved in closed form.
Keywords: Two-Sided Market, Network Effects, Monopoly Experimentation, Bayesian Learning, Optimal Control
JEL classification: D42, D83, L12

Full text in pdf format:

365.pdf

Vicarious Liability and the Intensity Principle

Abstract:

The present paper provides an economic analysis of vicarious liability that takes information rents and monitoring costs to be borne by the principal explicitly into account. In the presence of information rents or if the principal is wealth constrained herself, vicarious liability need not generate efficient precaution incentives. Rather, precaution incentives turn out to depend on the exact quantum of damages specified by courts. I shall compare incentives under three damages
regimes: strict liability, the traditional negligence rule, and proportional liability. To do so, I make use of the intensity principle that allows to rank damages regimes based on the monotonicity of differences of the principal's expected payof f as a function of induced precaution.

Keywords: vicarious liability, precaution incentives, judgement-proof principals and agents, discrepancy between private and social costs

JEL classification: K13, D62

October 2011

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364.pdf

The Benefits of Sequential Screening

Abstract:

This paper considers the canonical sequential screening model and shows that when the agent has an expost outside option, the principal does not benefit from eliciting the agent’s information sequentially. Unlike in the standard model without expost outside options, the optimal contract is static and conditions only on the agent’s aggregate final information. The benefits of sequential screening in the standard model are therefore due to relaxed participation rather than relaxed incentive compatibility constraints. We argue that in the presence of expost participation constraints, the classical, local approach fails to identify binding incentive constraints and develop a novel, inductive procedure to do so instead. The result extends to the multi–agent version of the problem.

Keywords: Sequential screening, dynamic mechanism design, participation constraints, Mirrlees approach

JEL Classification: D82, H57

October 2011

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363.pdf

A Note on “Modeling the Birth and Death of Cartels with An Application to Evaluating Competition Policy” by Harrington and Chang (2009)

Abstract:

Full text in pdf format:

362.pdf

Dynamic Coordination via Organizational Routines

Abstract:

We investigate dynamic coordination among members of a problem solving team who receive private signals about which of their actions are required for a (static) coordinated solution and who have repeated opportunities to explore different action combinations. In this environment ordinal equilibria, in which agents condition only on how their signals rank their actions and not on signal strength, lead to simple patterns of behavior that have a natural interpretation as routines. These routine spartially solve the team’s coordination problem by synchronizing the team’s search efforts and prove to be resilient to changes in the environment by being expost equilibria, to agents having only a coarse understanding of other agents’ strategies by being fully cursed, and to natural forms of agents’ overconfidence. The price of this resilience is that optimal routines are frequently not optimal equilibria.

January 2011

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355.pdf

Evaluating Leniency with Missing Information on Undetected Cartels: Exploring Time-Varying Policy Impacts on Cartel Duration

Abstract:

This paper examines the effects of European Commission’s (EC) new leniency program on the EC’s capabilities in detecting and deterring cartels. As a supplementary analysis, the US leniency is studied. I discuss a dynamic model of cartel formation and dissolution to illustrate how changes in antitrust policies and economic conditions might affect cartel duration. Comparative statics results are then corroborated with empirical estimates of hazard functions adjusted to account for both the heterogeneity of cartels and the time-varying policy impacts suggested by theory. Contrary to earlier studies, my statistical tests are consistent with the theoretic predictions that following an efficacious leniency program, the average duration of discovered cartels rises in the short run and falls in the long run. The results shed light on the design of enforcement programs against cartels and other forms of conspiracy.

Keywords: evaluation of antitrust policies, leniency, time-varying policy effects, missing observations,

sample selection bias.

Journal of Economic Literature Classification Numbers: D43, K21, K42, L13.

Full text in pdf format:

353_01.pdf

The efficient provision of public goods through non-distortionary tax contests

Abstract:

We use a simple balanced budget contest to collect taxes on a private good in order to finance a pure public good. We show that-with an appropriately chosen structure of winning probabilities-this contest can provide the public good efficiently and without distorting private consumption. We provide extensions to multiple public goods and private taxation sources, asymmetric preferences, and show the mechanism’s robustness across these settings.

Keywords: Taxation, Contests, Efficiency

JEL Classification: C7, D7

March 2011

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352.pdf

How to allocate Research (and other) Subsidies

Abstract:

A budget-constrained buyer wants to purchase items from a short-listed set. Items are differentiated by observable quality and sellers have private reserve prices for their items. The buyer’s problem is to select a subset of maximal quality. Money does not enter the buyer’s objective function, but only his constraints. Sellers quote prices strategically, inducing a knapsack game. We derive the Bayesian optimal mechanism for the buyer’s problem. We find that simultaneous take-it-or-leave-it offers are optimal. Hence, somewhat surprisingly, ex-postcompetition is not required to implement optimality. Finally, we discuss the problem in a detail free setting.

Keywords: Mechanism Design, Subsidies, Budget, Procurement, Knapsack Problem

JEL Classification: D21, D44, D45, D82

March 2011

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351.pdf

Determinants of Noneconomic Damages in Medical Malpractice Settlements and Litigations: Evidence from Texas since 1988

Abstract:

There have long been claims that compensations for noneconomic damages are random because tort law does not provide clear guidance regarding these compensations. I investigate, in both settled and tried medical malpractice cases, whether noneconomic damage payments are arbitrary and what determines the probability and size of these payments. I find that payments for noneconomic damages are not completely random. They vary, in predictable ways, with observable characteristics of the case. The data suggest similar patterns in non-medical malpractice cases. I end by discussing the implications of my findings for the debate on the efficiency and rationale of noneconomic damage compensation.

JEL Classification: K13, K32, K41

December 2010

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348.pdf

The Timing of Out-of-Court Settlements Revisited: Theory and Cross- Sectional Evidence from Texas since 1988

Abstract:

Legal institutions play an important role in affecting delay in settlement. But little research has investigated the institutional causes of delay. The empirical literature is ambiguous regarding the impact of trial-court delay on settlement delay. I analyze the timing of bargaining and the causes of delay using a cross-section of insurance claims in Texas over a 20-year span. I discuss a dynamic model of pretrial negotiation to illustrate how changes in the legal systems might affect the duration of settlement. Comparative statics results are then corroborated with empirical estimates of a hazard function adjusted to account for the heterogeneity of claims and the time dependence suggested by theory. Statistical tests are consistent with the theoretic prediction that delay in trial courts expedites out-of-court settlement. I also find that alternative dispute resolution, a legal process designed to save transaction costs, reduces the rapidity of settlement. Prejudgement interest, a law introduced to reduce delay, actually causes a greater delay in settlement. The results have implications for efficiency of the judicial system and reform efforts aiming to reduce delay.

Keywords: settlement delay, trial-court delay, prejudgment interest, alternative dispute resolution

JEL-Classification: C78, K41

December 2010

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347_01.pdf

Jackpot Justice: The Value of Inefficient Litigation

Abstract:

Litigation seems to be a Pareto-ineffcient outcome of pretrial bargaining; however, this paper shows that litigation can be the outcome of rational behavior by a litigant and her attorney. If the attorney has more information than his client concerning the characteristics of the lawsuit, the client can use litigation as a way of extracting information. I show that, counterintuitively, litigation will occur only when the plaintiff is pessimistic about her prospects at trial. Even if the plaintiff could obtain a higher payoff from bargaining than from litigation-without-bargaining, bargaining may not occur in equilibrium. The plaintiff is more likely to sue if she is more pessimistic about winning damage in court and if litigation is more risky. Litigation is less likely to occur if the plaintiff receives third party financing for litigation.

Keywords: settlement-litigation decision, costs of bargaining, non-bargaining, delegation of dispute resolution, risks of litigation, plaintiff-characteristic dependence,low plaintiff win rates

JEL Classification: C78, D74, D86, K41

November 2010

Full text in pdf format:

346.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

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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

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342.pdf

Two-sided Certification: The market for Rating Agencies

Abstract:

Certifiers contribute to the sound functioning of markets by reducing a symmetric information. They, however, have been heavily criticized during the 2008-09 financial crisis. This paper investigates on which side of the market a monopolistic profit-maximizing certifier offers his service. If the seller demands a rating, the certifier announces the product quality publicly, whereas if the buyer requests a rating it remains his private information. The model shows that the certifier offers his service to sellers and buyers to maximize his own profit with a higher share from the sellers. Overall, certifiers increase welfare in specific markets. Revenue shifts due to the financial crisis are also explained.

Keywords: Certification, Rating Agencies, Asymmetric Information, Financial Markets.
JEL Classification: G14, G24, L15, D82.

October 2010

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338.pdf

Horizontal mergers with synergies: first-price vs. profit-share auction

Abstract:

We consider takeover bidding in a Cournot oligopoly when firms have private information concerning the synergy effect of merging with a takeover target. Two auction rules are considered: standard first-price and profit-share auctions, supplemented by entry fees. Since non-merged firms benefit from a merger if the synergies are low, bidders are subject to a positive externality. Nevertheless, pooling does not occur; and the profit-share auction is strictly more profitable than the first-price auction, regardless of whether firms observe the synergy parameter or only the winning bid before they play the oligopoly game.

Keywords: Horizontal mergers, takeovers, auctions, externalities, oligopoly
JEL Classification: G34, D44, H23, L13, D43

October 2010

Full text in pdf format:

336.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

Information sharing in contests

Abstract:

We study the incentives to share private information ahead of contests, such as markets with promotional competition, procurement contests, or R&D. We consider the cases where firms have (i) independent values and (ii) common values of winning the contest. In both cases, when decisions to share information are made independently, sharing information is strictly dominated. With independent values, an industry-wide agreement to share information can arise in equilibrium. Expected effort is lower with than without information sharing. With common values, an industry-wide agreement to share information never arises in equilibrium. Expected effort is higher with than without information sharing.

Keywords: information sharing; contest; all-pay auction
JEL Classification: D82; D43; D44; L13; D74

September 2010

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334.pdf

Strategic Learning in Teams

Abstract:

This paper analyzes a two-player game of strategic experimentation with three-armed exponential bandits in continuous time. Players face replica bandits, with one arm that is safe in that it generates a known payoff, whereas the likelihood of the risky arms’ yielding a positive payoff is initially unknown. It is common knowledge that the types of the two risky arms are perfectly negatively correlated. I show that the efficient policy is incentive-compatible if, and only if, the stakes are high enough. Moreover, learning will be complete in any Markov perfect equilibrium with continuous value functions if, and only if, the stakes exceed a certain threshold.

Keywords: Strategic Experimentation, Three-Armed Bandit, Exponential Distribution, Poisson Process, Bayesian Learning, Markov Perfect Equilibrium
JEL Classification: C73, D83, O32

July 2010

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333.pdf

Infinitely Repeated Games with Public Monitoring and Monetary Transfers

Abstract:

In this paper, we study infinitely repeated games with imperfect public monitoring and the possibility of monetary transfers. We develop an effcient algorithm to compute the set of pure strategy public perfect equilibrium payoffs for each discount factor. We also show how all equilibrium payoffs can be implemented with a simple class of stationary equilibria that use stick-and-carrot punishments.

July 2010

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332.pdf

Existence of a pure-strategy Bayesian Nash equilibrium in imperfectly discriminating contests

Abstract:

We consider a general class of imperfectly discriminating contests with privately informed players. We show that findings by Athey (2001) imply the existence of a Bayesian Nash equilibrium in monotone pure strategies.

Keywords: contest, imperfectly discriminating, asymmetric information, equilibrium existence, interdependent values

JEL Classification: D72, D74, D82, C72

July 2010

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331.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

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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

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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

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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

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326.pdf

Separating Equilibria with Imperfect Certification

Abstract:

Viscusi (1978) shows how, in markets with quality uncertainty, perfect certification results in separation from top down due to an unraveling process similar to Akerlof (1970). De and Nabar (1991) argue that imperfect certification prevents unraveling so that equilibria with full separation do not exist. This note shows that, if one considers the buyers' buying decision explicitly, a separating equilibrium with imperfect certification does exist.

Keywords: certification, unraveling, separating equilibrium
JEL Classification: D82, L15

June 2010

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324.pdf

Who Should Pay for Certification?

Abstract:

Who does, and who should initiate costly certification by a third party under asymmetric quality information, the buyer or the seller? Our answer — the seller — follows from a non–trivial analysis revealing a clear intuition. Buyer–induced certification acts as an inspection device, whence seller–induced  certification acts as a signalling device. Seller–induced certification maximizes the certifier’s profit and social welfare. This suggests the general principle that certification is, and should be induced by the better informed party. The results are reflected in a case study from the automotive industry, but apply also to other markets – in particular the financial market.

Keywords: asymmetric information, certification, information acquisition, inspection, lemons, middlemen, signaling

JEL Classification: D40, D82, L14, L15

June 2010

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323.pdf

Mediated Contracts and Mechanism Design

Abstract:

This note relates the mechanisms that are based on mediated contracts of Rahman and Obara (2010) to the mechanisms of Myerson (1982). It shows that the mechanisms in Myerson (1982) are more general in that they encompass the mechanisms based on mediated contracts. It establishes an equivalence between the two classes if mediated contracts are allowed to be stochastic.

Keywords: mediatedcontract, mechanismdesign, revelationprinciple, moralhazard

May 2010

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322.pdf

On Liability Insurance for Automobiles

Abstract:

Car owners are liable for property damage inflicted on other motorists. In most countries such liability must be insured by law. That law may favor expensive or heavy vehicles, prone to suffer or inflict large losses. This paper explores links between liability rules and vehicle choice. It presumes cooperative insurance, but non-cooperative acquisition of vehicles. Thus, the Nash equilibrium and its degree of efficiency depend on the liability regime. 

Keywords: liability, mutual insurance, core, pure Nash equilibrium, anonymous games, non-atomic measure

JEL Classification: C71, C72, D61, K13

May 2010

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321.pdf

Using Forward Contracts to Reduce Regulatory Capture

Abstract:

A fully unbundled, regulated network firm of unknown efficiency level can untertake unobservable effort to increase the likelihood of low downstream prices, e.g. by facilitating downstream competition. To incentivize such effort, the regulator can use an incentive scheme paying transfers to the firm contingent on realized downstream prices. Alternatively, the regulator can force the firm to sell the following forward contracts: the firm pays the downstream price to the owners of a contract, but recieves the expected value of the contracts when selling them to a competivitve financial market. We compare the two regulatory tools with respect to regulatory capture: if the regulator can be bribed to suppress information on the underlying state of the world (the basic propability of high downstream prices, or the type of the firm), optimal regulation uses forward contracts only.

Keywords: incentive regulation, regulatory capture, virtual power plants

JEL Classification: L42, L51, K23, L94

February 2010

Full text in pdf format:

320.pdf

Hierarchical Structures and Dynamic Incentives

Abstract:

We study the optimal hierarchical structure of an organization under limited commitment. The organization cannot make a long term commitment to wages and output levels, while it can commit to its hierarchical structure. We show that the optimal hierarchical structure is horizontal when it is highly likely that the employees are efficient or inefficient.
By contrast, when such likelihood is intermediate or output does not expand very fast over time, the optimal hierarchical structure is vertical - with a vertical hierarchy, the organization can mitigate dynamic incentive problems linked to limited commitment.

Key words: Dynamic Incentives, Organization Design

JEL Classification: D82, D86

April 2010

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318.pdf

Information acquisition in conflicts

Abstract:

This paper considers incentives for information acquisition ahead of conflicts. First, we characterize the (unique) equilibrium of the all-pay auction between two players with one-sided asymmetric information where one player has private information about his valuation. Then, we use ou rresults to study information acquisition prior to an all-pay auction. If the decision to acquire information is observable, but not the informatio nreceived, one-sided asymmetric information can occur endogenously in equilibrium. Moreover, the cutoff values of the cost of information that determine equilibrium information acquisition are higher  than in the first best.  Thus, information  acquisition is excessive. Incontrast, with open or covert information acquisition,  the equilibrium cut-off values are as in the  first best.

 
Keywords: All-pay auctions; Conflicts; Contests; Information acquisition;
Asymmetric information
JEL Classification: D72; D74; D82; D83

March 2010

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314.pdf

Rent-seeking Contests under Symmetric and Asymmetric Information

Abstract:

We consider a variant of the Tullock rent-seeking contest. Under symmetric information we determine equilibrium strategies and prove their uniqueness. Then, we assume contestants to be privately informed about their costs of effort. We prove existence of a pure-strategy equilibrium and provide a sufficient condition for uniqueness. Comparing different informational settings we find that if players are uncertain about the costs of all players, aggregate effort is lower than under both private and complete information. Yet, under additional assumptions, rent dissipation is still smaller in the latter settings. Numerical examples illustrate that there is no general ranking between private and complete information. The results depend on the distribution costs are drawn from and on the exact specification of the contest success function.

Keywords: Rent-seeking, Contest, Asymmetric Information, Private values

JEL Classification: D72, D74, D82, C72

March 2010

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311.pdf

A dynamic auction for multi-object procurement under a hard budget constraint

Abstract:

We present a new dynamic auction for procurement problems where payments are bounded by a hard budget constraint and money does not enter the procurer's objective function.

Keywords: Auctions, Mechanism Design, Knapsack Problem, Dominant Strategy, Budget, Procurement

JEL Classification: D21, D44, D45, D82

March 2010

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310.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

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308.pdf

Innovation Contests with Entry Auction

Abstract:

We consider procurement of an innovation from heterogeneous sellers. Innovations are random but depend on unobservable effort and private information. We compare two procurement mechanisms where potential sellers first bid in an auction for admission to an innovation contest. After the contest, an innovation is procured employing either a fixed prize or a first-price auction. We characterize Bayesian Nash equilibria such that both mechanisms are payoff-equivalent and induce the same efforts and innovations. In these equilibria, signaling in the entry auction does not occur since contestants play a simple strategy that does not depend on rivals' private information.

Keywords: Contest, Auction, Innovation, Research, R\&D, Procurement, Signaling

JEL Classification: D21, D44, D82, H57, O31, O32

February 2010

Full text in pdf format:

307.pdf

Technology Adoption, Social Learning, and Economic Policy

Abstract:

We study a two-player dynamic investment model with information externalities and provide necessary and sufficient conditions for a unique switching equilibrium. When the public information is sufficiently high and a social planer therefore expects an investment boom, investments should be taxed. Conversely, any positive investment tax is suboptimally high if the public information is sufficiently unfavorable.We also show that an investment tax may increase overall investment activity.

Keywords: Information Externality, Strategic Waiting, Delay, Information Cascade, Investment Boom, Optimal Taxation

JEL Classification: D62, D83

February 2010

Full text in pdf format:

306.pdf

Optimal Procurement Contracts with Pre–Project Planning

Abstract:

The paper studies procurement contracts with pre–project investigations in the presence of adverse selection and moral hazard. To model the procurer’s  roblem, we extend a standard sequential screening model to endogenous information acquisition with moral hazard. The optimal contract displays systematic distortions in information acquisition. Due to a rent effect, adverse selection induces too much information acquisition to prevent cost overruns and too little information acquisition to prevent false project cancelations. Moral hazard mitigates the distortions related to cost overruns yet exacerbates those related to false negatives. The optimal mechanism is a menu of option contracts that achieves the dual goal of providing incentives for information acquisition and truthful information revelation.

Keywords: Information acquisition, procurement, dynamic mechanism design
JEL Classification: D82, H57

January 2010

Full text in pdf format:

303.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

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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

Strategic Vertical Separation

Abstract:

The paper explores incentives for strategic vertical separation of firms in a framework of a simple duopoly model. Each firm chooses either to be a retailer of its own good (vertical integration) or to sell its good through an independent exclusive retailer (vertical separation). In the latter case a two-part tariff is applied. Retailers compete in quantities, goods are perfect substitutes and firms' cost functions are quadratic. I show that the equilibrium outcome crucially depends on the degree of (dis)economies of scale and asymmetry of costs. Two asymmetric equilibria arise, in which one firm separates while another integrates, under conditions that both firms' cost functions exhibit a sufficiently high diseconomies of scale, or extreme asymmetry of costs. Under a moderate asymmetry of costs a unique equilibrium exists in which the firm with the lower degree of diseconomies of scale separates, while its rival integrates. With the degree of diseconomies of scale low for both firms in the unique equilibrium both firms separate.

Keywords: Vertical oligopoly; Vertical Separation; Vertical Integration, Delegation

JEL Classification: L22; L42

September 2009

Full text in pdf format:

296.pdf

The High/Low Divide: Self- Selection by Values in Auction Choice

Abstract:

Most prior theoretical and experimental work involving auction choice has assumed bidders only find out their value after making a choice of which autcion to enter. In this paper we examine whether or not subjects knowing their value prior to making an auction choice impacts their choice decision and/or the outcome of the auctions. The results show a strong impact. Subjects with low values choose the first price sealed bid auction more often while subjects with high values choose the ascending auction more often. The average numbers of bidders in both formats ended up being on average the same, but due to the self-selection bias the ascending auction raised as much revenue on average as the first sealed bid auction. The two formats also generate efficiency levels that are roughly equivalent though the earnings of bidders are higher in the ascending auction.

Keywords: bidder preferences, private values, sealed bid auctions, ascending auctions, endogenous entry

JEL Classification: C91, D44

January 2010

Full text in pdf format:

295.pdf

Buy-It-Now prices in eBay Auctions - The Field in the Lab

Abstract:

Electronic commerce has grown extraordinarily over the years, with online auctions being extremely successful forms of trade. Those auctions come in a variety of different formats, such as the Buy-It-Now auction format on eBay, that allows sellers to post prices at which buyers can purchase a good prior to
the auction. Even though, buyer behavior is well studied in Buy-It-Now auctions, as to this point little is known about how sellers set Buy-It-Now prices. We investigate into this question by analyzing seller behavior in Buy-It-Now auctions. More precisely, we combine the use of a real online auction market (the eBay platform and eBay traders) with the techniques of lab experiments. We find a striking link between the information about agents provided by the eBay market institution and their behavior. Information about buyers is correlated with their deviation from true value bidding. Sellers respond strategically to this information when deciding on their Buy-It-Now prices. Thus, our results highlight potential economic consequences of information publicly available in (online) market institutions.

Keywords: electronic markets, experience, online auctions, BIN price, buyout
price, single item auction, private value, experiment

JEL Classification: C72, C91, D44, D82

January 2010

Full text in pdf format:

294.pdf

Signaling in Auctions among Competitors

Abstract:

We consider a model of oligopolistic firms that have private information about their cost structure. Prior to competing in the market a competitive advantage, i.e., a cost reducing technology, is allocated to a subset of the firms by means of a multi-object auction. After the auction either all bids or only the prices to be paid are revealed to all firms. This provides an opportunity for signaling. Whether there exists an equilibrium in which bids perfectly identify the bidders’ costs generally depends on the type and fierceness of the market competition, the specific auction format, and the bid announcement policy.

Keywords: Auction; Oligopoly; Signaling

JEL Classification: D44, L13, D43, D82, C72

January 2010

Full text in pdf format:

293.pdf

Licensing a common value innovation when signaling strength may backfire

Abstract:

This paper reconsiders the licensing of a common value innovation to a downstream duopoly, assuming a dual licensing scheme that combines a first-price license auction with royalty contracts for losers. Prior to bidding firms observe imperfect signals of the expected cost reduction; after the auction the winning bid is made public. Bidders may signal strength to their rivals through aggressive bidding, which may however backfire and mislead the innovator to set an excessively high royalty rate. We provide sufficient conditions for existence of monotone bidding strategies and for the profitability of combining auctions and royalty contracts for losers.

Keywords: Patents, licensing, auctions, royalty, innovation, R&D, mechanism design.
JEL Classification: D21, D43, D44, D45.

January 2010

Full text in pdf format:

292.pdf

Auctioning Process Innovations when Losers’ Bids Determine Royalty Rates

Abstract:

We consider a licensing mechanism for process innovations that combines a license auction with royalty contracts to those who lose the auction. Firms’ bids are dual signals of their cost reductions: the winning bid signals the own cost reduction to rival oligopolists, whereas the losing bid influences the beliefs of the innovator who uses that information to set the royalty rate. We derive conditions for existence of a separating equilibrium, explain why a sufficiently high reserve price is essential for such an equilibrium, and show that the innovator generally benefits from the proposed mechanism.

Keywords: Patents, licensing, auctions, royalty, innovation, R&D, mechanism design.
JEL Classification: D21, D43, D44, D45.

December 2009

Full text in pdf format:

291.pdf

On and Off Contract Remedies

Abstract:

A party dissatisfied with the contractual performance of a counterparty is typically able to pursue a variety of legal recourses. Within this apparent variety lurk two fundamental alternatives. The aggrieved party may (i) “affirm” the contract and seek money damages or specific performance; or (ii) “disaffirm” the contract with the remedy of rescission and restitution. This simple dichotomy of contract remedies applies broadly in both common law and civil law practice. We show here that this remedial regime allows parties to write simple contracts that induce first-best cooperative investments.

Keywords: breach remedies, incomplete contracts, cooperative investments.
JEL Classification: K12, L22, J41, C70.

December 2009

Full text in pdf format:

290.pdf

Insolvency and Biased Standards - The Case for Proportional Liability

Abstract:

We analyze liability rules in a setting where injurers are potentially insolvent and where negligence standards may deviate from the socially optimal level. We show that proportional liability, which sets the measure of damages equal to the harm multiplied by the probability that it was caused by an injurer’s negligence, is preferable to other existing negligence-based rules. Moreover, proportional liability outperforms strict liability if the standard of due care is not set too low. Our analysis also suggests that courts should rely on statistical evidence and bar individualized causal claims that link the harm suffered by a plaintiff to the actions of the defendant. Finally, we provide a result which might be useful to regulators when calculating minimum capital requirements or minimum mandatory insurance for different industries.

 
Keywords: judgment proof problem, uncertain causation, court error and misperception, proportional liability, disgorgement

JEL Classification: K13

December 2009

Full text in pdf format:

289.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

Wages and Productivity Growth in a Dynamic Oligopoly

Abstract:

This paper studies the innovation dynamics of an oligopolistic industry. The firms compete not only in the output market but also by engaging in productivity enhancing innovations to reduce labor costs. Rent sharing may generate productivity dependent wage differentials. Productivity growth creates intertemporal spill-over effects, which affect the incentives for innovation at subsequent dates. Over time the industry equilibrium approaches a steady state. The paper characterizes the evolution of the industry's innovation behavior and its market structure on the adjustment path.

Keywords: innovation, laborproductivity, oligopoly, wagedifferentials, productivitygrowth, industrydynamics

JEL Classification: D24, D42, D92, J31

November 2009

Full text in pdf format:

287.pdf

Breach Remedies Including Hybrid Investments

Abstract:

We show that parties in bilateral trade can rely on the default common law breach remedy of  ‘expectation damages’ to induce simultaneously first-best relationship-specific investments of both the selfish and the cooperative kind. This can be achieved by writing a contract that specifies a suffciently high quality level. In contrast, the result by Che and Chung (1999) that ‘reliance damages’ induce the firstbest in a setting of purely cooperative investments, does not generalize to the hybrid case. We also show that if the quality specified in the contract is too low, ‘expectation damages’ do not necessarily induce the ex-post effcient trade decision in the presence of cooperative investments.

Keywords: breach remedies, incomplete contracts, hybrid investments, cooperative investments, selfish investments

JEL Classification: K12, L22, J41, C70

October 2009

Full text in pdf format:

282.pdf

Signaling an Outside Option

Abstract:

We consider the case of an upstream seller who works to
improve an asset that has been specialized to a downstream buyer's needs. The buyer then makes a take it or leave it offer to the seller about how the future surplus should be split. We assume that the seller from the outset has private information about the fraction of the surplus that he can realize on his own, and show that this leads to higher investment compared to the complete information case. This positive effect on investment is countervailed by the occurrence of inefficient separations, which result when the buyer mistakenly tries to call the seller's bluff with a low offer.

Keywords: signaling, relationship-specific investment, incomplete contracts, outside options

JEL Classification:D23, D82

October 2009

Full text in pdf format:

281.pdf

Product Durability in Markets with Consumer Lock-in

Abstract:

This paper examines a two-period duopoly where consumers are locked-in by switching costs that they face in the second period. The paper's main focus is on the question of how the consumer lock-in affects the firms' choice of product durability. We show that firms may face a prisoners' dilemma situation in that they simultaneously choose non-durable products although they would have higher profits by producing durables. From a social welfare perspective, firms may even choose an inefficiently high level of product durability.

Keywords: Consumer Lock-in, Product Durability, Duopoly

JEL Classification: L13, D21

October 2009

Full text in pdf format:

279.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

Full text in pdf format:

274.pdf

Monopoly Distortions in Durability and Multi-Dimensional Quality

Abstract:

I show that Swan’s (1970) independence result requires a multiplicative interaction between durability and all other quality attributes. Because there is no compelling argument for a multiplicativity in quality, monopolists tend to distort durability, even with constant marginal costs. Distortions in durability and other quality aspects are aligned exactly when the marginal cost of quality do not increase too much with durability.

Keywords: Durability, quality, monopoly
JEL Classification: L15

September 2009

Full text in pdf format:

271.pdf

Screening and Merger Activity

Abstract:

In our paper targets, by setting a reserve price, screen acquirers on their (expected) ability to generate merger-specific synergies. Both empirical evidence and many common merger models suggest that the difference between high- and low-synergy mergers becomes smaller during booms. This implies that the target’s opportunity cost for sorting out relatively less fitting acquirers increases and, hence, targets screen less tightly during booms, which leads to a hike in merger activity. Our screening mechanism not only predicts that merger activity is intense during economic booms and subdued during recessions but is also consistent with other stylized facts about takeovers and generates novel testable predictions.

Keywords: Takeovers, Merger Waves, Defense Tactics, Screening

JEL Classification: D21, D80, L11.

August 2009

Full text in pdf format:

270.pdf

Nationalizations and effciency

Abstract:

We develop a theoretical model in which firms are either private or state-owned. When firms become insolvent, the government can intervene with general measures, like subsidies, or by nationalizing firms. The government only intervenes when the bankruptcy of a firm entails social costs. In a stylized model, we analyze how government interventions affect allocative and productive efficiency. Nationalization of private firms in case unprofitable investments were made, leads to increased allocative efficiency despite private ownership. The effort level chosen by the managers working for firms is also affected by government intervention with an impact on productive efficiency.

Keywords: nationalization, efficiency

JEL Classification: L33, P31, P51

July 2009

Full text in pdf format:

268.pdf

Sabotage in dynamic tournaments

Abstract:

This paper studies sabotage in a dynamic tournament. Three players compete in two rounds. In the final round, a player who is leading in the race, but not yet beyond the reach of his competitors, gets sabotaged more heavily. As a consequence, if players are at the same position initially, they do not work productively or sabotage at all in the first round. Thus sabotage is not only directly destructive, but also depresses incentives to work productively. If players are heterogeneous ex ante, sabotage activities in the first round may be concentrated against an underdog, contrary to findings from static tournaments. We also discuss the robustness of our results in a less stylized environment.

Keywords: dynamic tournaments, contests, sabotage, heterogeneity

June 2009

Full text in pdf format:

266.pdf

Investments and the Holdup Problem in a Matching Market

Abstract:

This paper studies investment incentives in the steady state of a dynamic bilateral matching market. Because of search frictions, both parties in a match are partially locked–in when they bargain over the joint surplus from their sunk investments. The associated holdup problem depends on market conditions and is more important for the long side of the market. In the case of investments in homogenous capital only the agents on the short side acquire ownership of capital. There is always underinvestment on both sides of the market. But when market frictions become negligible, the equilibrium investment levels tend towards the first–best.

Keywords: Holdup Problem, Matching Market, Investments

JEL Classification: C78, D23, D92

June 2009

Full text in pdf format:

263.pdf

Prizes and Lemons: Procurement of Innovation under Imperfect Commitment

Abstract:

The literature on R&D contests implicitly assumes that contestants submit their innovation regardless of its value. This ignores a potential adverse selection problem. The present paper analyzes the procurement of innovations when the procurer cannot commit to never bargain with innovators who bypass the contest. We compare fixed-prize tournaments with and without entry fees, and optimal scoring auctions with and without minimum score requirement. Our main result is that the optimal fixed-prize tournament is more profitable than the optimal auction since preventing bypass is more costly in the optimal auction.

Keywords: innovation, contests, tournaments, auctions, bargaining, adverse
selection

JEL Classification: C70, D44, D89, L12, O32

June 2009

Full text in pdf format:

262_01.pdf

Signal-Jamming in a Sequential Auction

Abstract:

In a recurring auction early bids may reveal bidders’ types, which in turn affects bidding in later auctions. Bidders take this into account and may bid in a way that conceals their private information until the last auction is played. The present paper analyzes the equilibrium of a sequence of first-price auctions assuming bidders have stable private values. We show that signal-jamming occurs and explore the dynamics of equilibrium prices.

Keywords: Auctions, Signaling, Price Competition

JEL Classification: D44, D02, D43

June 2009

Full text in pdf format:

261_01.pdf

Strategic Experimentation with Poisson Bandits

Abstract:

We study a game of strategic experimentation with two-armed bandits where the risky arm distributes lump-sum payoffs according to a Poisson process. Its intensity is either high or low, and unknown to the players. We consider Markov perfect equilibria with beliefs as the state variable. As the belief process is piecewise deterministic, payoff functions solve differential-difference equations.  here is no equilibrium where all players use cut-off strategies, and all equilibria exhibit an ‘encouragement effect’ relative to the single-agent optimum. We construct asymmetric equilibria in which players have symmetric continuation values at sufficiently optimistic beliefs yet take turns playing the risky arm before all experimentation stops. Owing to the encouragement effect, these equilibria Pareto dominate the unique symmetric one for sufficiently frequent turns. Rewarding the last experimenter with a higher continuation value increases the range of beliefs where players experiment, but may reduce average payoffs at more optimistic beliefs. Some equilibria exhibit an ‘anticipation effect’: as beliefs become more pessimistic, the continuation value of a single experimenter increases over some range because a lower belief means a shorter wait until another player takes over.

Keywords: Strategic Experimentation, Two-Armed Bandit, Poisson Process, Bayesian Learning, Piecewise Deterministic Process, Markov Perfect Equilibrium, Differential-Difference Equation

JEL Classification: C73, D83, O32

May 2009

Full text in pdf format:

260.pdf

Renegotiation-Proof Relational Contracts with Side Payments

Abstract:

We study infinitely repeated two player games with perfect information, where each period consists of two stages: one in which the parties simultaneously choose an action and one in which they can transfer money to each other. We first derive simple conditions that allow a constructive characterization of all Pareto-optimal subgame perfect payoffs for all discount factors. Afterwards, we examine different concepts of renegotiation-proofness and extend the characterization to renegotiation-proof payoffs.

Keywords: renegotiation, infinitely repeated games, side payments, optimal penal codes

JEL Classification: C73, L14

April 2009

Full text in pdf format:

259.pdf

Optional linear input prices in vertical relations

Abstract:

This paper examines how the option of a regulated linear input price affects vertical contracting, where a monopolistic upstream supplier sequentially offers supply contracts to two symmetric downstream firms. We find that equilibrium contracts vary with production cost and regulated price level: If the regulated price is not too high, the option allows for price discrimination, but prevents foreclosure in the intermediary market. Indeed, if both cost and optional price are rather low, non-discriminatory input prices below cost may arise. Optional input prices are socially more desirable than a flat ban on price discrimination, as consumers benefit from more intense downstream competition.

Keywords: price discrimination, vertical contracting, exclusion, regulatory outside option

JEL Classification: D42, L11, L42

April 2009

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258.pdf

Platform Standards, Collusion and Quality Incentives

Abstract:

This paper examines how quality incentives are related to the interoperability of competing platforms. Platforms choose whether to operate standardised or exclusively, prior to quality and subsequent price competition. We find that platforms choose a common standard if they can
coordinate their quality provision. The actual investment then depends on the cost of quality provision: If rather high, platforms refrain from investment; if rather low, platforms maintain vertically differentiated platforms. The latter case is socially more desirable than exclusivity where platforms do not invest. Nevertheless, quality competition of standardised platforms induces the highest investment and maximum welfare.

Keywords: two-sided markets, standards, investment in transaction quality

JEL Classification: D43, D62, L13

January 2009

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257.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

Subsidies, Knapsack Auctions and Dantzig’s Greedy Heuristic

Abstract:

A budget-constrained buyer wants to purchase items from a shortlisted set. Items are differentiated by quality and sellers have private reserve prices for their items. Sellers quote prices strategically, inducing a knapsack game. The buyer’s problem is to select a subset of maximal quality. We propose a buying mechanism which can be viewed as a game theoretic extension of Dantzig’s greedy heuristic for the classic knapsack problem. We use Monte Carlo simulations to analyse the performance of our mechanism. Finally, we discuss how the mechanism can be applied to award R&D subsidies.

Keywords: Auctions, Subsidies, Market Design, Knapsack Problem

JEL Classification: D21, D43, D44, D45

Febuary 2009

Full text in pdf format:

254.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

Exit Options in Incomplete Contracts with Asymmetric Information

Abstract:

This paper analyzes bilateral contracting in an environment with contractual incompleteness and asymmetric information. One party (the seller) makes an unverifiable quality choice and the other party (the buyer) has private information about its valuation. A simple exit option contract, which allows the buyer to refuse trade, achieves the first–best in the benchmark cases where either quality is verifiable or the buyer’s valuation is public information. But, when unverifiable and asymmetric information are combined, exit options induce inefficient pooling and lead to a particularly simplecontract. Inefficient pooling is unavoidable also under the most general form of contracts, which make trade conditional on the exchange of messages between the parties. Indeed, simple exit option contracts are optimal if random mechanisms are ruled out.

Keywords: Incomplete Contracts, Asymmetric Information, Exit Options
JEL Classification: D82, D86, L15

Novmber 2008

Full text in pdf format:

251.pdf

The optimal prize structure of symmetric Tullock contests

Abstract:

We show that the optimal prize structure of symmetric n-player Tullock tournaments assigns the entire prize pool to the winner, provided that a symmetric pure strategy equilibrium exists. If such an equilibrium fails to exist under the winner-take-all structure, we construct the optimal prize structure which improves existence conditions by dampening efforts. If no such optimal equilibrium exists, no symmetric pure strategy equilibrium induces positive efforts.

Keywords: Tournaments, Incentive structures, Rent seeking
JEL Classification: C7, D72, J31

November 2008

Full text in pdf format:

250.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

Full text in pdf format:

249.pdf

Breach Remedies, Performance Excuses, and Investment Incentives

Abstract:

Contract law is usually perceived as a strict liability system. When a promisor fails to perform he is held liable even if he is without fault. If, however, an unusual contingency has arisen he may be excused from performing provided that he has taken reasonable precautions. For a setting with uncertain costs of and benefits from performance, it is shown that a fixed price contract is sufficient to generate efficient reliance and precautions incentives under the following legal regime. If the promisor has met the appropriate precaution standard then he is excused if performance fails to be profitable. Alternative regimes, in contrast, where he is excused if performance is inefficient or even is extremely costly distort investment incentives quite generally.

Keywords: performance excuse, impracticability doctrine, overreliance, efficient precaution
JEL Classification: K12
September 2008

Full text in pdf format:

247.pdf

Collusion and Durability

Abstract:

We develop a model to show that cartels that produce goods with lower durability are easier to sustain implicitly. This observation gen- erates the following results: 1) implicit cartels have an incentive to pro- duce goods with an inefficiently low level of durability; 2) a monopoly or explicit cartel is welfare superior to an implicit cartel; 3) welfare is non-monotonic in the number of firms; 4) a regulator may demand inefficiently high levels of durability to prevent collusion.

Keywords: cartels, collusion, durability
JEL Classification: L15
September 2008

Full text in pdf format:

246.pdf

Negatively Correlated Bandits

Abstract:

We analyze a two-player game of strategic experimentation with two-armed bandits. Each player has to decide in continuous time whether to use a safe arm with a known payoff or a risky arm whose likelihood of delivering payoffs is initially unknown. The quality of the risky arms is perfectly negatively correlated between players. In marked contrast to the case where both risky arms are of the same type, we find that learn- ing will be complete in any Markov perfect equilibrium if the stakes exceed a certain threshold, and that all equilibria are in cutoff strategies. For low stakes, the equilib- rium is unique, symmetric, and coincides with the planner's solution. For high stakes, the equilibrium is unique, symmetric, and tantamount to myopic behavior. For inter- mediate stakes, there is a continuum of equilibria.

Keywords: Strategic Experimentation, Two-Armed Bandit, Exponential Distribution, Poisson Process, Bayesian Learning, Markov Perfect Equilibrium
JEL Classification: C73, D83, O32
August 2008

Full text in pdf format:

243.pdf

Standard Breach Remedies, Quality Thresholds, and Cooperative Investments

Abstract:

When investments are non-verifiable, inducing cooperative investments with simple contracts may not be as difficult as previously thought. Indeed, modeling 'expectation damages' close to legal practice, we show that the default remedy of contract law induces the first best. Yet, in order to lower informational requirements of courts, parties may opt for a 'specific performance' regime which grants the breached-against buyer an option to choose 'restitution' if the tender's value falls below some (exogenously given) quality threshold. In order to implement this regime, no more information needs to be verifiable than is implicitly assumed in Che and Hausch (1999).

Keywords: breach remedies, imcomplete contracts, cooperative investments
JEL Classification: K12, L22, J41, C70
July 2008

Full text in pdf format:

242.pdf

Centralized and decentralized provision of public goods

Abstract:

We model the trade-off between centralized and decentralized decision making over the provision of local public goods. Centralized decisions are made in a legislature of locally elected representatives, and this creates a conflict of interest between citizens in different jurisdictions. The legislature can be self-interested or benevolent and this can result in either efficient, excessive or misallocative provision of public goods. Decisions are inuenced by spillover effects and differences in jurisdictionalsize. Furthermore, we look at the incentives for centralization.

Keywords: decentralization, local public goods
JEL Classification: H40, H70, P51
July 2008

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241.pdf

Optimal Contracts for Lenient Supervisors

Abstract:

We consider a situation where an agent's effort is monitored by a supervisor who cares for the agent's well being. This is modeled by incorporating the agent's utility into the utility function of the supervisor. The first best solution can be implemented even if the supervisor's preferences are unknown. The corresponding optimal contract is similar to what we observe in practice: The supervisor's wage is constant and independent of his report. It induces one type of supervisor to report the agent's performance truthfully, while all others report favorably independent of performance. This implies that overstated performance (leniency bias) may be the outcome of optimal contracts under informational asymmetries.

Keywords: Subjective performance evaluation, leniency, supervisor, private infrmation
JEL Classification: D82, D86, J33, M52
June 2008

Full text in pdf format:

237.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

Legal Damages for Losses of Chances

Abstract:

This paper deals with legal damages if losses of chances are at stake. In response to disparate ad hoc rules that have emerged from legal practice in Europe, the present paper proposes a unifying principle to handle such cases. Quite generally, the purpose of a damages award is to compensate the claimant and should be based on the difference in value between due performance and actual performance. To cope with limited observability, it is suggested to still award the difference though on average over the observed event. The paper calculates damages in line with this general principle. The proposed damage scheme is shown to fully compensate the victim and to provide efficient incentives for precaution, be it that multiple injurers act non-cooperatively or in concert, even if losses of chances are at stake.

Keywords: estimating legal damages, liability for torts, liability for breach of contracts, uncertain causation,difference hypothesis
JEL classification: K12, K13, D62
February 2008

Full text in pdf format:

235.pdf

Expectation Damages, Divisible Contracts, and Bilateral Investment

Abstract:

This paper examines the efficiency of expectation damages as a breach remedy in a bilateral trade setting with renegotiation and relationship-specific investment by the buyer and the seller. As demonstrated by Edlin and Reichelstein (1996), no contract that specifies only a fixed quantity and a fixed per-unit price can induce efficient investment if marginal cost is constant and deterministic. We show that this result does not extend to more general payoff functions. If both parties face the risk of breaching, the first best becomes attainable with a simple price-quantity contract.

Keywords: breach remedies, renegotiation, hold-up
JEL classification: K12, D86, L14
March 2008

Full text in pdf format:

231.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

Full text in pdf format:

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

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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

Full text in pdf format:

228.pdf

Opportunistic Termination

Abstract:

If a seller delivers a good non-conforming to contract, European and US warranty law allows consumers to choose between some money transfer and termination. Termination rights are, however, widely criticized, mainly for fear that the buyer may use non-conformity as a pretext for getting rid of a contract he no longer wants. We show that this possibility of 'opportunistic termination' might actually have positive effects. Under some circumstances, it will lead to redistribution in favour of the buyer without any loss of efficiency. Moreover, by curbing the monopoly power of the seller, a regime involving termination might increase welfare by enabling a more efficient output level in a setting with multiple buyers.

Keywords: contract law, warranties, breach remedies, termination, harmonization
JEL classification: K12, C7, L40, D30
August 2008

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226_01.pdf

Plaintiffs exploiting Plaintiffs

Abstract:

We consider a model of a single defendant and N plaintiffs where the total cost of litigation is fixed on the part of the plaintiffs and shared among the members of a suing coalition. By settling and dropping out of the coalition, a plaintiff therefore creates a negative externality on the other plaintiffs. It was shown in Che and Spier (2007) that failure to internalize this externality can often be exploited by the defendant. However, if plaintiffs make sequential take-it-or-leave-it settlement offers, we can show that they will actually be exploited by one of their fellow plaintiffs rather than by the defendant. Moreover, if litigation is a public good as is the case in shareholder derivative suits, parties may fail to reach a settlement even having complete information. This may explain why we observe derivative suits in the US but not in Europe.

Keywords: litigation, settlement, bargaining, contracting with externalities, derivative suits, public goods
JEL classification: K41, C7, H4
January 2008

Full text in pdf format:

224.pdf

Does Interbank Borrowing Reduce Bank Risk?

Abstract:

In this paper we investigate whether banks that borrow from other banks have lower risk levels. We concentrate on a large sample of Central and Eastern European banks which allows us to explore the impact of interbank lending when exposures are long-term and interbank borrowers are small banks. The results of the empirical analysis generally confirm the hypothesis that long-term interbank exposures result in lower risk of the borrowing banks.

Keywords: interbank market, bank risk, market discipline, transition countries
JEL classification: G21, E53
November 2007

Full text in pdf format:

223.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

Allocation of Authority when a Person is not a Robot

Abstract:

We formalize a conception of authority, which is commonly defined as the right of controlling a person’s actions embedded in human assets in sociology. Due to the inalienable property of human assets, the contractible formal authority is hard to verify and enforce, while real authority usually diverges from formal authority. Inefficiency tends to arise when a task is not routine or can not be done by a robot. Using a framework of incomplete contract, we show that allocation of formal authority, as an instrument to mitigate the inefficiency, is determined by features of tasks and specificity of assets, and the relationship between the resources. Monitoring is then introduced to fine tune value of delegation.

Keywords: Transaction of human assets, real authority, formal authority, delegation, monitor
JEL Classification: D23, J24, J41, L22.
July 2007

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211.pdf

Efficient Inequity–Averse Teams

Abstract:

This paper analyzes the efficiency of team production when agents exhibit other regarding preferences. It is shown that full efficiency can be sustained as an equilibrium through a budget-balancing mechanism that punishes some randomly chosen agents if output falls short of efficient level but distributes the output equally otherwise, provided that the agents are sufficiently inequity averse.

Keywords: moral hazard, team production, inequity aversion
JEL Classification: C7, D7, D63, L2
May 2007

Full text in pdf format:

210.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

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202.pdf

License Auctions with Royalty Contracts for (Winners and) Losers

Abstract:

This paper revisits the licensing of a non–drastic process innovation by an outside innovator to a Cournot oligopoly. We propose a new mechanism that combines a restrictive license auction with royalty licensing. This mechanism is more profitable than standard license auctions, auctioning royalty contracts, fixed–fee licensing, pure royalty licensing, and two-part tariffs. The key features are that royalty contracts are auctioned and that losers of the auction are granted the option to sign a royalty contract. Remarkably, combining royalties for winners and losers makes the integer constraint concerning the number of licenses irrelevant.

Keywords: patents, licensing, auctions, royalty, innovation, R&D, mechanism design
JEL Classification: D21, D43, D44, D45
April 2007

Full text in pdf format:

199.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

Garbled Elections

Abstract:

Majority rules are frequently used to decide whether or not a public good should be provided, but will typically fail to achieve an efficient provision. We provide a worst-case analysis of the majority rule with an optimally chosen majority threshold, assuming that voters have independent private valuations and are exante symmetric (provision cost shares are included in the valuations). We show that if the population is large it can happen that the optimal majority rule is essentially no better than a random provision of the public good. But the optimal majority rule is worst-case asymptotically efficient in the large-population limit if (i) the voters’ expected valuation is bounded away from 0, and (ii) an absolute bound for valuations is known.

October 2006

Full text in pdf format:

195.pdf

Providing Public Goods Without Strong Sanctioning Institutions

Abstract:

This paper proposes a simple mechanism aimed to establish positive contributions to public goods in the absence of powerful institutions to sanction free-riders. The idea of the mechanism is to require players to commit to the public good by paying a deposit prior to the contribution stage. If all players commit in this way, those players who do not contribute their share to the public good forfeit their deposit. If there is no universal commitment, all deposits are refunded and the standard game is played. Given deposits are sufficiently high, prior commitment and full ex post contributions are part of a strict subgame perfect Nash equilibrium for the resulting game. As the mechanism obviates the need for any ex post prosecution of free-riders, it is particularly suited for situations where players do not submit to a common authority as in the case of international agreements.

Keywords: public goods, cooperation, institutions, Climate-Change Treaties
JEL Classification: C72, D61
February 2007

Full text in pdf format:

194.pdf

Why and How Identity Should Influence Utility

Abstract:

This paper provides an argument for the advantage of a preference for identity-consistent behaviour from an evolutionary point of view. Within a stylised model of social interaction, we show that the development of cooperative social norms is greatly facilitated if the agents of the society possess a preference for identity consistent behaviour. As cooperative norms have a positive impact on aggregate outcomes, we conclude that such preferences are evolutionarily advantageous. Furthermore, we discuss how such a preference can be integrated in the modelling of utility in order to account for the distinctive cooperative trait in human behaviour and show how this squares with the evidence.

Keywords: cognitive dissonance, fairness, identity, reciprocity, social Norms, social preferences, utility
JEL Classification: A13, C70, C90, D01, Z13
January 2007

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193.pdf

Can’t Buy Me Rights! The Contractual Structure of Asymmetrical Inter-firm Collaborations

Abstract:

The efficient allocation of control rights in inter-firm collaborations is a widely emphasized issue. In this paper, I empirically identify control rights and the allocation of these rights using a unique survey data set on collaborations between biotechnology and pharmaceutical firms. Fifteen control rights are
identified to make up the structure of deals with five rights being the items of contention in deal making (ownership of patents, production, further development of the technology, the right to manage the collaboration, and the right to market universally). I find that the assignment of control rights is related to the bargaining position of firms and incentive issues. Hence, goliaths –pharmaceutical incumbents
– subrogate critical rights to the new ventures when the final outcome of the project is depending on the venture’s effort.

Keywords: contracts, performance, inter-firm collaboration, biotechnology
JEL Classification: D23, L24, G30, M13, O32

December 2006

Full text in pdf format:

189.pdf

Country size and publicly provided goods

Abstract:

This paper studies the equilibrium size of countries. Individuals in small countries have greater influence over the nature of political decision making while individuals in large countries have the advantage of more public goods and lower tax rates. The model implies that (i) there exists excessive incentives to separate, though this need not be the case for all sets of secession rules studied; (ii) an exogenous increase in public spending decreases country size; (iii) countries with a presidential-congressional democracy are larger than countries with a parliamentary democracy.

Keywords: country size, public spending, structure of government
JEL classification: D7, H1, H2, H7
December 2006

Full text in pdf format:

187.pdf

Collective Production and Incentives

Abstract:

We analyse incentive problems in collective production environments where contributors are compensated according to their observed and ranked efforts. This provides incentives to the contributors to choose first best efforts.

December 2006

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186.pdf

How eBay Sellers set “Buy-it-now” prices - Bringing The Field Into the Lab

Abstract:

In this paper we introduce a new type of experiment that combines the advantages of lab and field experiments. The experiment is conducted in the lab but using an unchanged market environment from the real world. Moreover, a subset of the standard subject pool is used, containing those subjects who have experience in conducting transactions in that market environment. This guarantees the test of the theoretical predictions in a highly controlled environment and at the same time enables not to miss the specific features of economic behavior exhibited in the field. We apply the proposed type of experiment to study seller behavior in online auctions with a Buy-It-Now feature, where early potential bidders have the opportunity to accept a posted price offer from the seller before the start of the auction. Bringing the field into the lab, we invited eBay buyers and sellers into the lab to participate in a series of auctions on the eBay platform. We investigate how traders' experience in a real market environment influences their behavior in the lab and whether abstract lab experiments bias subjects' behavior.

Keywords: online auctions, experiments, buyout prices
JEL Classification: C72, C91, D44, D82
November 2006

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181.pdf

Do individuals recognize cascade behavior of others? An Experimental Study

Abstract:

In an information cascade experiment participants are confronted with artificial predecessors predicting in line with the BHW model (Bikchandani et al., 1992). Using the BDM (Becker et al., 1964) mechanism we study participants' probability perceptions based on maximum prices for participating in the prediction game. We find increasing maximum prices the more coinciding predictions of predecessors are observed, regardless of whether additional information is revealed by these predictions. Individual price patterns of more than two thirds of the participants indicate that cascade behavior of predecessors is not recognized.

Keywords: information cascades, Bayes' Rule, decision under risk and uncertainty, experimental economics
JEL Classification: C91, D81, D82
October 2006

Full text in pdf format:

180.pdf

Revenue Equivalence Revisited

Abstract:

The conventional wisdom in the auction design literature is that first price sealed bid auctions tend to make more money while ascending auctions tend to be more efficient. We re-examine these issues in an environment in which bidders are allowed to endogenously choose in which auction format to participate. Our findings are that more bidders choose to enter the ascending auction than the first price sealed bid auction and this extra entry is enough to make up the revenue difference between the formats. Consequently, we find that both formats raise approximately the same amount of revenue. They also generate efficiency levels and bidder earnings that are roughly equivalent across mechanisms though the earnings in the ascending might be slightly higher. In expected utility terms though, we find that the expected utility of entering a first price sealed bid auction is greater than entering an ascending for any risk averse bidder suggesting that we are seeing “overentry” into the ascending auctions.

Keywords: bidder preferences, private values, sealed bid auctions, ascending auctions, endogenous entry
JEL Classification: C91, D44
October 2006

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175.pdf

Anomalies in Auction Choice Behavior

Abstract:

Ivanova-Stenzel and Salmon (2004a) established some interesting yet puzzling results regarding bidders’ preferences between auction formats. The finding is that bidders strongly prefer the ascending to the first price sealed bid auction on a ceteris paribus basis but they are not willing to pay up to an entry price for entering into an ascending auction instead of a first price that would equalize the profits between the two. While it was found that risk aversion on the part of the bidders could resolve this anomaly the claim that risk aversion drives overbidding in first price auctions is somewhat controversial. In this study we examine two competing explanations for the observed behavior; loss aversion and “clock aversion”, i.e. a dislike for some aspect of the clock based bidding mechanism. We find that neither alternative explanation can account for bidders’ auction choice behavior leaving risk aversion as the only un-falsified hypothesis.

Keywords: bidder preferences, private values, sealed bid auctions, ascending auctions
JEL Classification: C91, D44
October 2006

Full text in pdf format:

174.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

Size and soft budget constraints

Abstract:

There is much evidence against the so-called "too big to fail" hypothesis in the case of bailouts to sub-national governments. We look at a model where districts of different size provide local public goods with positive spillovers. Matching grants of a central government can induce socially-efficient provision, but districts can still exploit the intervening central government by inducing direct financing. We show that the ability of a district to induce a bailout from the central government and district size are negatively correlated.

Keywords: bailouts, soft-budget constraints, jurisdictional size, public goods, spillovers
JEL Classification: H4, H7, R1
October 2006

Full text in pdf format:

172.pdf

Procurement with Costly Bidding, Optimal Shortlisting, and Rebates

Abstract:

We consider the procurement of a complex, indivisible good when bid preparation is costly, assuming a population of heterogeneous contractors. Shortlisting is introduced to implement the optimal number of bidders, and we explore whether the procurer should reimburse the nonrecoverable cost of preparing a bid in whole or in part. We find that a reimbursement policy is profitable for the procurer only if performance and bidding costs are negatively correlated. Moreover, negative rebates (entry fees) always dominate positive rebates.

Keywords: Procurement, Auctions, Entry
JEL classification: D44, D45
September 2006

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166.pdf

Research Joint Ventures, Optimal Licensing, and R&D Subsidy Policy

Abstract:

We reconsider the justifications of R&D subsidies by Spencer and Brander (1983) and others by allowing firms to pool R&D investments and license innovations. In equilibrium R&D joint ventures are formed and licensing occurs in a way that eliminates the strategic benefits of R&D investment in the subsequent oligopoly game. Nevertheless, governments subsidize their domestic firms in order to raise their bargaining position in the joint venture. This holds true regardless of whether governments offer either unconditional or conditional subsidies. This suggests an alternative explanation of the observed proliferation of R&D subsidies.

Keywords: patent licensing, industrial organization, R&D subsidies, research joint ventures, technology policy
JEL classification: L13, O34
September 2006

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165.pdf

On the Explanatory Value of Inequity Aversion Theory

Abstract:

In a number of papers on their theory of Inequity Aversion, E. Fehr and K. Schmidt have claimed that the theory explains the behavior in many experiments. By virtue of having an infinite number of parameters the theory can predict a wide range of outcomes, from the competitive to the cooperative. Its prediction depends on values of these parameters. Fehr & Schmidt provide no explicit methodological plan for their project and as a result they repeatedly make logical and methodological errors. We look at the methodology of their explanations and find that no connection has been established between the experimental data and the behavior predicted by the theory. We conclude that the theory of inequity aversion has no explanatory value beyond its trivial capacity to predict a broad range of outcomes as a function of its parameters.

September 2006

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164.pdf

Reliance Investments, Expectation Damages and Hidden Information

Abstract:

A setting of reliance investments is explored where one of the parties to a contract obtains private information concerning his utility or cost function that remains hidden to the other party and to courts. As a consequence, it will be a difficult task to award expectation damages corrrectly to a party with private information who sufffers from breach of contract. While a revelation mechanism would exist that leads to the first best solution, assessing expectation damages correctly turns out to be at odds with ex post efficiency. I conclude that, under asymmetric information, the performance of expectation damages falls short of what more general mechanisms could achieve.

Keywords: reliance investments, expectation damages, breach of contract, hidden information
JEL classification: K12, D82
September 2006

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162.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

Legal Damages at Uncertain Causation

Abstract:

The legal notion of damages requires to compare the actual value of the creditor’s assets with the hypothetical value that would have prevailed if the debtor had met his obligation. Moreover, values and causation may be uncertain. If nature’s contribution is modelled as a random move then the interaction between debtor and nature can be described in normal form which, in turn, allows to capture causality and legal damages in a consistent way. In practice, such random moves of nature are rarely observable. Yet, statistical inference may reveal sufficient information to test for causation and to estimate legal damages on average over observable events as the present paper will establish.

Keywords: estimating legal damages, liability for torts, liability for breach of contracts
JEL Classification: K13, K12, D62
August 2006

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160.pdf

Sovereign Risk Premiums in the European Government Bond Market

Abstract:

This paper provides a study of bond yield differentials among EU government bonds issued between 1993 and 2005 on the basis of a unique dataset of issue spreads in the US and DM (Euro) bond market. Interest differentials between bonds issued by EU countries and Germany or the USA contain risk premiums which increase with fiscal imbalances and depend negatively on the issuer's relative bond market size. The start of the European Monetary Union has shifted market attention to debt service payments as the key measure of indebtedness and eliminated liquidity premiums in the euro area.

Keywords: asset pricing, determination of interest rates, fiscal policy, government debt
JEL Classification: G12, E43, E62, H63
May 2006

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151.pdf

The design of fiscal rules and forms of governance in European Union countries

Abstract:

This paper uses a new data set on budgetary institutions in Europe to examine the impact of fiscal rules and budget procedures in EU countries on public finances. It briefly describes the main pattern of budgetary institutions and their determinants across the EU 15 member states. Empirical evidence for the time period 1985-2004 suggests that the centralisation of budgeting procedures restrains public debt. In countries with one-party governments or coalition governments where parties are closely aligned and where political competition among them is low, this is achieved by the delegation of decision-making power to the minister of finance. Fiscal contracts that require countries to set multi-year targets and that reinforce those targets increase fiscal discipline in countries with ideologically dispersed coalitions and where parties regularly compete against each other.

Keywords: public indebtedness, budgetary procedures, fiscal rules, European public finances
JEL Classification: H11, H61, H62
June 2006

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150.pdf

Political Economy of Fiscal Institutions

Abstract:

We discuss two essential problems of the political economy of public finances: The principal agent problem between voters and elected politicians and the common pool problem arising from the fact that money drawn from a general tax fund is used to pay for policies targeting more or less narrow groups in society. Three institutional mechanisms exist to deal with these problems, ex-ante rules controlling the behavior of elected policy makers, electoral rules creating accountability of and competition among policy makers, and budgeting processes internalizing the common pool externality. We review recent theoretical and empirical research and discuss its implications for research and institutional design.

Keywords: electoral systems, fiscal rules, budgeting processes
JEL Classification: H11, H61, H62
November 2005

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149.pdf

What do deficits tell us about debt? Empirical evidence on creative accounting with fiscal rules in the EU

Abstract:

Fiscal rules, such as the Excessive Deficit Procedure and the Stability and Growth Pact (SGP), aim at constraining government behavior. Milesi-Ferretti (2003) develops a model in which governments circumvent such rules by reverting to creative accounting. The amount of this depends on the reputation cost for the government and the economic cost of sticking to the rule. We provide empirical evidence of creative accounting in the European Union. We find that the SGP rules have induced governments to use stock-flow adjustments, a form of creative accounting, to hide deficits. The tendency to substitute stock-flow adjustments for budget deficits is especially strong for the cyclical component of the deficit, as in times of recession the cost of reducing the deficit is particularly large.

Keywords: Fiscal rules, stock-flow adjustments, debt-deficit adjustments, stability and growth pact, excessive deficit procedure, ESA 95
JEL Classification: E62, H61, H62, H 63, H 70
January 2006

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148.pdf

Fiscal Rules and Fiscal Performance in the EU and Japan

Abstract:

Fiscal rules specify quantitative targets for key budgetary aggregates. In this paper, we review the experience with such rules in Japan and in the EU. Comparing the performance of fiscal policy in the 1980s and 1990s until 2003, we find that the fiscal rule of the 1980s exerted some but not much disciplinary influence on Japanese fiscal policy. The fiscal rule of the Maastricht Treaty had a significant impact on political budget cycles in the EU, but did little to constrain fiscal policy in the large member states. Since the start of the European Monetary Union, the disciplinary effect of the fiscal rule in the EU has vanished. Next, we discuss the importance of budgetary institutions for the effectiveness of fiscal rules. In Europe, a number of countries adopted strong fiscal rules, i.e., a fiscal rule combined with a design of the budget process enabling governments to commit to the rule. We find that strong fiscal rules have been effective. We conclude with some suggestions for the design of a strong fiscal rule in Japan.

Keywords: Fiscal policy, political budget cycles, government budgeting
JEL Classification: H11, H61, H62
June 2006

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147.pdf

Budget Processes: Theory and Experimental Evidence

Abstract:

This paper studies budget processes, both theoretically and experimentally. We compare the outcomes of bottom-up and top-down budget processes. It is often presumed that a top-down budget process leads to a smaller overall budget than a bottom-up budget process. Ferejohn and Krehbiel (1987) showed theoretically that this need not be the case. We test experimentally the theoretical predictions of their work. The evidence from these experiments lends strong support to their theory, both at the aggregate and the individual subject level.

Keywords: Budget processes, voting equilibrium, experimental economics
JEL Classification: H61, C91, C92
March 2006

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146.pdf

Tournaments with Midterm Reviews

Abstract:

In many tournaments investments are made over time and conducting a review only once at the end, or also at points midway through, is a strategic decision of the tournament designer. If the latter is chosen, then a rule according to which the results of the different reviews are aggregated into a ranking must also be determined. This paper takes a first step in the direction of answering how such rules are optimally designed. A characterization of the optimal aggregation rule is provided for a two-agent two-stage tournament. In particular, we show that treating the two reviews symmetrically may result in an equilibrium effort level that is inferior to the one in which only a final review is conducted. However, treating the two reviews lexicographically by first looking at the final review, and then using the midterm review only as a tie-breaking rule, strictly dominates the option of conducting a final review only. The optimal mechanism falls somewhere in between these two extreme mechanisms. It is shown that the more effective the first-stage effort is in determining the final review’s outcome, the smaller is the weight that should be assigned to the midterm review in determining the agents’ ranking.

May 2006

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145.pdf

When queueing is better than push and shove

Abstract:

We address the scheduling problem of reordering an existing queue into its efficient order through trade. To that end, we consider individually rational and balanced budget direct and indirect mechanisms. We show that this class of mechanisms allows us to form efficient queues provided that existing property rights for the service are small enough to enable trade between the agents. In particular, we show on the one hand that no queue under a fully deterministic service schedule such as first-come, first-serve can be dissolved efficiently and meet our requirements. If, on the other hand, the alternative is service anarchy (ie. a random queue), every existing queue can be transformed into an efficient order.

Keywords: Scheduling, Queueing, Mechanism design
JEL Classification: C72, D44, D82
June 2006

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144.pdf

On Seller Estimates and Buyer Returns

Abstract:

This paper revisits recent empirical research on buyer credulity in arts auctions and auctions for assets in general. We show that elementary results in auction theory can fully account for some stylized facts on asset returns that have been held to suggest that sellers of assets can exploit buyers by providing biased estimates of asset values. We argue that, rather than showing that buyers are credulous, the existing evidence can serve as an indirect test of the rationality assumptions underlying auction theory.

Keywords: Auctions, information disclosure, seller manipulation, buyer credulity
JEL Classification: D44, D82, G12, G14
February 2006

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143.pdf

Allocative and Informational Externalities in Auctions and Related Mechanisms

Abstract:

We study the effects of allocative and informational externalities in (multi-object) auctions and related mechanisms. Such externalities naturally arise in models that embed auctions in larger economic contexts. In particular, they appear when there is downstream interaction among bidders after the auction has closed. The endogeneity of valuations is the main driving force behind many new, specific phenomena with allocative externalities: even in complete information settings, traditional auction formats need not be efficient, and they may give rise to multiple equilibria and strategic non-participation. But, in the absence of informational externalities, welfare maximization can be achieved by Vickrey-Clarke- Groves mechanisms. Welfare-maximizing Bayes-Nash implementation is, however, impossible in multi-object settings with informational externalities, unless the allocation problem is separable across objects (e.g. there are no allocative externalities nor complementarities) or signals are one-dimensional. Moreover, implementation of any choice function via ex-post equilibrium is generically impossible with informational externalities and multidimensional types. A theory of information constraints with multidimensional signals is rather complex, but indispensable for our study.

October 2005

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142.pdf

Mixed Bundling Auctions

Abstract:

We study multi-object auctions where agents have private and additive valuations for heterogeneous objects. We focus on the revenue properties of a class of dominant strategy mechanisms where a weight is assigned to each partition of objects. The weights influence the probability with which partitions are chosen in the mechanism. This class contains efficient auctions, pure bundling auctions, mixed bundling auctions, auctions with reserve prices and auctions with pre-packaged bundles. For any number of objects and bidders, both the pure bundling auction and separate, efficient auctions for the single objects are revenue-inferior to an auction that involves mixed bundling.

February 2006

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141.pdf

Optimal Seedings in Elimination Tournaments

Abstract:

We study an elimination tournament with heterogenous contestants whose ability is common-knowledge. Each pair-wise match is modeled as an all-pay auction where the winner gets the right to compete at the next round. Equilibrium efforts are in mixed strategies, yielding rather complex play dynamics: the endogenous win probabilities in each match depend on the outcome of other matches through the identity of the expected opponent in the next round. The designer can seed the competitors according to their ranks. For tournaments with four players we find optimal seedings with respect to three different criteria: 1) maximization of total effort in the tournament; 2) maximization of the probability of a final among the two top ranked teams; 3) maximization of the win probability for the top player. In addition, we find the seedings ensuring that higher ranked players have a higher probability to win the tournament. Finally, we compare the theoretical predictions with data from NCAA basketball tournaments.

Keywords: Elimination tournaments, Seedings, All-Pay Auctions
JEL Classification: D72, D82, D44
July 2003

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140.pdf

Abstract:

We study the optimal design of organizations under the assumption that agents in a contest care about their relative position. A judicious definition of status categories can be used by a principal in order to influence the agents’ performance. We first consider a pure status case where there are no tangible prizes. Our main results connect the optimal partition in status categories to various properties of the distribution of ability among contestants. The top status category always contains an unique element. For distributions of abilities that have an increasing failure rate, a proliferation of status classes is optimal, while in other cases the optimal partition involves some coarseness. Finally, we modify the model to allow for status categories that are endogenously determined by monetary prizes of different sizes. If status is solely derived from monetary rewards, we show that the optimal partition in status classes contains only two categories.

July 2005

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139.pdf

Labour market screening with intermediaries

Abstract:

We consider a Rothschild-Stiglitz-Spence labour market screening model and employ a centralised mechanism to coordinate the efficient matching of workers to firms. This mechanism can be thought of as operated by a recruitment agency, an employment office or head hunter. In a centralised descending-bid, multi-item procurement auction, workers submitwage-bids for each job and are assigned stable jobs as equilibrium outcome. We compare this outcome to independent, sequential hiring by firms and conclude that, in general, a stable assignment can only be implemented if firms coordinate to some extent.

Keywords: Matching, Multi-item auctions, Sequential auctions, Screening
JEL Classification: C78, D44, E24, J41
June 2006

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138.pdf

Sequential bargaining with pure common values

Abstract:

We study the alternating-offers bargaining problem of assigning an indivisible and commonly valued object to one of two players in return for some payment among players. The players are asymmetrically informed about the object’s value and have veto power over any settlement. There is no depreciation during the bargaining process which involves signalling of private information. We characterise the perfect Bayesian equilibrium of this game which is essentially unique if offers are required to be strictly increasing. Equilibrium agreement is reached gradually and nondeterministically. The better informed player obtains a rent.

Keywords: Sequential bargaining, Common values, Incomplete information, Repeated games
JEL Classification: C73, C78, D44, D82, J12
June 2006

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137.pdf

Sequential bargaining with pure common values and incomplete information on both sides

Abstract:

We study the alternating-offer bargaining problem of sharing a common value pie under incomplete information on both sides and no depreciation between two identical players. We characterise the essentially unique perfect Bayesian equilibrium of this game which turns out to be in gradually increasing offers.

Keywords: Gradual bargaining, Common values, Incomplete information, Repeated games
JEL Classification: C73, C78, D44, D82, J12
June 2006

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136.pdf

Failure to Delegate and Loss of Control

Abstract:

This paper provides an explanation for the frequently observed phenomenon of “inefficient micromanagement”. I show that a supervisor may get comprehensively involved into activities of a subordinate although a better option of delegation is available. This inefficiency persists in the absence of conflict of preferences and even as the cost of delegation becomes zero. The paper also demonstrates that imposing constraints on communication with a subordinate can be beneficial for a superior.

October 2004

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130.pdf

Veto-Based Delegation

Abstract:

In a principal-agent model with hidden information and no monetary transfers, I establish the Veto-Power Principle: any incentive-compatible outcome can be implemented through veto-based delegation with an endogenously chosen default decision. This result demonstrates the exact nature of commitment powers required by the principal: (1) to design the default outcome and (2) to ensure that she has almost no formal control over the agent's decisions.

Keywords: veto power, asymmetric information, principal-agent relationship, no monetary transfers.
JEL Classification: D78, D82, L22, M54
January 2005

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129.pdf

A Characterization of the Conditions for Optimal Auction with Resale

Abstract:

Zheng has proposed a seller-optimal auction for (asymmetric) independent-privatevalue environments where inter-bidder resale is possible. Zheng’s construction requires novel conditions — Resale Monotonicity, Transitivity, and Invariance — on the bidders’ value distribution profile. The only known examples of distribution profiles satisfying these conditions in environments with three or more bidders are uniform distributions. Our characterization result shows that Zheng’s conditions, while being strong, are satisfied by many non-uniform distribution profiles. A crucial step in our analysis is to show that Invariance implies Resale Monotonicity and Transitivity.

Keywords: independent private values, optimal auction, resale, inverse virtual valuation function
May 2006

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128.pdf

First-mover disadvantage

Abstract:

This note considers a bargaining environment with two-sided asymmetric information and quasilinear preferences in which parties select bargaining mechanism after learning their valuations. I demonstrate that sometimes the buyer achieves a higher ex-ante payoff if the bargaining mechanism is selected by her opponent rather than by herself. In the model, the buyer has limited wealth and in addition to acquiring one good from the seller can purchase a different good from a competitive market. The positive relation between the values of these goods is what delivers our result.

JEL Classification: C72, C78, D82
October 2005

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127.pdf

Contests with multi-tasking

Abstract:

The standard contest model in which participants compete in a single dimension is well understood and documented. Multi-dimension extensions are possible but are liable to increase the complexity of the contest structure, mitigating one of its main advantages: simplicity. In this paper we propose an extension in which competition ensues in several dimensions and a competitor that wins a certain number of these is awarded a prize. The amount of information needed to run the contest is hence limited to the number of dimensions won by each player. We look at the design of this contest from the point of view of maximizing effort in the contest (per dimension and totally), and show that there will be a tendency to run small contests with few dimensions. The standard Tullock model and its results are encompassed by our framework.

Keywords: contest design, multi-tasking, effort incentives
JEL Classification: D72
May 2006

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125.pdf

Fragmented property rights and R&D competition

Abstract:

Where product innovation requires several complementary patents, fragmented property rights can be a factor that limits firms’ willingness to invest in the development and commercialization of new products. This paper studies multiple simultaneous R&D contests for complementary patents and how they interact with patent portfolios that firms may have acquired already. We also consider how this interaction and the intensity of the contests depends on the type of patent trade regimes and the product market equilibria that result from these regimes. We solve for the contest equilibria and show that the multiple patent product involves an important hold-up problem that considerably reduces the overall contest effort.

Keywords: fragmented property rights, patents, contests, hold-up, R&D, patent pools, licensing
JEL Classification: D44
June 2006

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123.pdf

Multi-battle contests

Abstract:

We study equilibrium in a multistage race in which players compete in a sequence of simultaneous move component contests. Players may win a prize for winning each component contest, as well as a prize for winning the overall race. Each component contest is an all-pay auction with complete information. We characterize the unique equilibrium analytically and demonstrate that it exhibits endogenous uncertainty. Even a large lead by one player does not fully discourage the other player, and each feasible state is reached with positive probability in equilibrium (pervasiveness). Total effort may exceed the value of the prize by a factor that is proportional to the maximum number of stages. Important applications are to war, sports, and R&D contests and the results have empirical counterparts there.

Keywords: all-pay auction, contest, race, conflict, multi-stage, R&D, endogenous uncertainty, preemption, discouragement
JEL Classification: D72, D74
March 2006

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122.pdf

Equilibrium and Efficiency in the Tug-of-War

Abstract:

We characterize the unique Markov perfect equilibrium of a tug-of-war without exogenous noise, in which players have the opportunity to engage in a sequence of battles in an attempt to win the war. Each battle is an all-pay auction in which the player expending the greater resources wins. In equilibrium, contest effort concentrates on at most two adjacent states of the game, the "tipping states", which are determined by the contestants’ relative strengths, their distances to final victory, and the discount factor. In these states battle outcomes are stochastic due to endogenous randomization. Both relative strength and closeness to victory increase the probability of winning the battle at hand. Patience reduces the role of distance in determining outcomes. Applications range from politics, economics and sports, to biology, where the equilibrium behavior finds empirical support: many species have developed mechanisms such as hierarchies or other organizational structures by which the allocation of prizes are governed by possibly repeated conflict. Our results contribute to an explanation why. Compared to a single stage conflict, such structures can reduce the overall resources that are dissipated among the group of players.

Keywords: winner-take-all, all-pay auction, tipping, multi-stage contest, dynamic game, preemption, conflict, dominance
JEL Classification: D72, D74
May 2006

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121.pdf

Contests with Investment

Abstract:

Perfectly discriminating contests (or all pay auction) are widely used as a model of situations where individuals devote resources to win some prize. In reality such contests are often preceded by investments of the contestants into their ability to fight in the contest. This paper studies a two stage game where in the first stage, players can invest to lower their bid cost in a perfectly discriminating contest, which is played in the second stage. Different assumptions on the timing of investment are studied. With simultaneous investments, equilibria in which players play a pure strategy in the investment stage are asymmetric, exhibit incomplete rent dissipation, and expected effort is reduced relative to the game without investment. There also are symmetric mixed strategy equilibria with complete rent dissipation. With sequential investment, the first mover always invests enough to deter the second mover from investing, and enjoys a first mover advantage. I also look at unobservable investments and endogenous timing of investments.

Keywords: contests, all pay auctions, investment
JEL Classification: D44, D72
May 2006

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120.pdf

Rents, dissipation and lost treasures: comment

Abstract:

In an interesting recent paper, Dari-Mattiacci and Parisi (2005) extended Tullock.s (1980) rent-seeking game with an entry decision. The mixed strategies identified by Dari-Mattiacci and Parisi for the case of increasing returns in the contest success function (r > 2) do not constitute an equilibrium of the game they study. However, these strategies are an equilibrium if the strategy space of the game is restricted by a minimum expenditure requirement, and this minimum expenditure requirement is an element of a specific interval.

January 2006

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119.pdf

Selection Tournaments, Sabotage, and Participation

Abstract:

This paper studies sabotage in tournaments with at least three contestants, where the contestants know each other well. Every contestant has an incentive to direct sabotage specifically against his most dangerous rival. In equilibrium, contestants who choose a higher productive effort are sabotaged more heavily. This might explain findings from psychology, where victims of mobbing are sometimes found to be overachieving. Further, sabotage equalizes promotion chances. The effect is most pronounced if the production function is linear in sabotage, and the cost function depends only on the sum of all sabotage activities: in an interior equilibrium, who will win is a matter of chance, even when contestants differ a great deal in their abilities. This, in turn, has adverse consequences for who might want to participate in a tournament. Since better contestants anticipate that they will be sabotaged more strongly, it may happen that the most able stay out and the tournament selects one of the less able with probability one. I also study the case where some contestants are easy victims, i.e. easier to sabotage than others.

Keywords: tournament, contest, sabotage, selection
JEL Classification: M51, J41, J29
April 2006

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118.pdf

All Nash Equilibria of the Multi-Unit Vickrey Auction

Abstract:

This paper completely characterizes the set of Nash equilibria of the Vickrey auction for multiple identical units when buyers have non-increasing marginal valuations and there at least three potential buyers. There are two types of equilibria: In the first class of equilibria there are positive bids below the maximum valuation. In this class, above a threshold value all bidders bid truthfully on all units. One of the bidders bids at the threshold for any unit for which his valuation is below the threshold; the other bidders bid zero in this range. In the second class of equilibria there are as many bids at or above the maximum valuation as there are units. The allocation of these bids is arbitrary across bidders. All the remaining bids equal zero. With any positive reserve price equilibrium becomes unique: Bidders bid truthfully on all units for which their valuation exceeds the reserve price.

Keywords: Vickrey auction, Multi-unit auction, ex-post equilibrium, reserve price, uniqueness
JEL Classification: C72, D44
June 2006

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116.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

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115.pdf

How to Allocate R&D (and Other) Subsidies: An Experimentally Tested Policy Recommendation

Abstract:

This paper evaluates how R&D subsidies to the business sector are typically awarded. We identify two sources of ine_ciency: the selection based on a ranking of individual projects, rather than complete allocations, and the failure to induce competition among applicants in order to extract and use information about the necessary funding. In order to correct these ine_- ciencies we propose mechanisms that include some form of an auction in which applicants bid for subsidies. Our proposals are tested in a simulation and in controlled lab experiments. The results suggest that adopting our proposals may considerably improve the allocation.

Keywords: Research, Subsidies, Experimental Economics
JEL classification: D44, D45, H25, O32, O38
October 2005

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108.pdf

Tortious Acts Affecting Markets

Abstract:

The present paper examines an injurer causing a temporary blackout to a firm as the primary victim but also affecting customers and competitors of the firm. Reflecting existing legal practice, the paper investigates efficiency properties of the negligence rule granting recovery of private losses but to the primary victim only. The regime is shown to provide efficient incentives for precaution provided that the primary loss exceeds the social loss from accidents. The main contribution of the paper consists of an explicit analysis of markets affected by a temporary blackout of one firm. The analysis reveals that the private loss exceeds the social loss indeed if the market is less than fully competitive. Moreover, the net social loss remains positive, no matter which market structure prevails.

JEL Classification: K13, K12, D62
April 2006

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106.pdf

Incentives for separation and incentives for public good provision

Abstract:

In this paper I examine the incentives of regions to unite, to separate and to provide public goods. Separation allows for greater influence over the nature of political decision making while unification allows regions to exploit economies of scale in the provision of public goods. When public good provision is relatively inexpensive, separation occurs since individuals want to assert greater influence, while for intermediate costs of public good provision, separation can be explained by the desires for greater influence as well as for more public goods. Compared with the social optimum, there are excessive incentives for public good provision as well as excessive incentives for separation.

Keywords: unification, separation, public good provision, voting
JEL Classification: D7, H2, H7
March 2006

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104.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

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102.pdf

License Auctions with Royalty Contracts for Losers

Abstract:

This paper revisits the standard analysis of licensing a cost reducing innovation by an outside innovator to a Cournot oligopoly. We propose a new mechanism that combines elements of a license auction with royalty licensing by granting the losers of the auction the option to sign a royalty contract. The optimal new mechanism eliminates the losses from exclusionary licensing without reducing bidders’ surplus; therefore, it is more profitable than both standard license auctions and pure royalty licensing. We also take into account that the number of licenses must be an integer, which is typically ignored in the literature.
Keywords: Patents, Licensing, Auctions, Royalty, Innovation, R&D, Mechanism Design
JEL classification: D21, D43, D44, D45
January 2006

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96.pdf

Conflict and the Social Contract

Abstract:

We consider social contracts for resolving conflicts between two agents who are uncertain about each other's fighting potential. Applications include international conflict, litigation, and elections. Even though only a peaceful agreement avoids a loss of resources, if this loss is small enough, then any contract must assign a positive probability of conflict. We show how the likelihood of conflict outbreak depends on the distribution of power between the agents and their information about each other.

Keywords: conflict, social contracts, asymmetric information
JEL Classification: C78, D72, D74, D82, H21, H23.

February 2006

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94.pdf

Procurement of Goods and Services – Scope and Government

Abstract:

December 2005

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93.pdf

Price formation in a sequential selling mechanism

Abstract:

This paper analyzes the trade of an indivisible good within a two-stage mechanism, where a seller first negotiates with one potential buyer about the price of the good. If the negotiation fails to produce a sale, a second–price sealed–bid auction with an additional buyer is conducted. The theoretical model predicts that with risk neutral agents all sales take place in the auction rendering the negotiation prior to the auction obsolete. An experimental test of the model provides evidence that average prices and profits are quite precisely predicted by the theoretical benchmark. However, a significant large amount of sales occurs already during the negotiation stage. We show that risk preferences can theoretically account for the existence of sales during the negotiation stage, improve the fit for buyers’ behavior, but is not sufficient to explain sellers’ decisions. We discuss other behavioral explanations that could account for the observed deviations.

Keywords: auction, negotiation, combined mechanism, sequential mechanism, risk preferences, experiment
JEL Classification: C72, C91, D44, D82
October 2005

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92.pdf

Courtesy and Idleness: Gender Differences in Team Work and Team Competition

Abstract:

Does gender play a role in the context of team work? Our results based on a real-effort experiment suggest that performance depends on the composition of the team. We find that female and male performance differ most in mixed teams with revenue sharing between the team members, as men put in significantly more effort than women. The data also indicate that women perform best when competing in pure female teams against male teams whereas men perform best when women are present or in a competitive environment.

Keywords: team incentives, gender, tournaments
JEL Classification: C72, C73, C91, D82
September 2005

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91.pdf

Corruption in Procurement Auctions

Abstract:

We review different kinds of corruption that have been observed in procurement auctions and categorize them. We discuss means to avoid corruption, by choice of preferable auction formats, or with the help of technological tools, such as secure electronic bidding systems. Auctions that involve some soft elements, such as complex bids consisting of technical and financial proposals, are particularly prone to corruption. We do not believe that it is possible to eradicate corruption altogether in such situations, but we discuss means to make it less likely.

January 2006

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90.pdf

Research Joint Ventures, Licensing, and Industrial Policy

Abstract:

This paper reconsiders the explanation of R&D subsidies by Spencer and Brander (1983) and others by allowing firms to license their innovations and to pool their R&D investments. We show that in equilibrium R&D joint ventures are formed and licensing occurs in a way that eliminates the strategic benefits of R&D investment in the export oligopoly game. Nevertheless, national governments are driven to subsidize their own national firms in order to increase their strength in the joint venture bargaining game. Therefore, our analysis suggests an alternative explanation of the observed proliferation of R&D subsidies.

Keywords: patent licensing, industrial organization, R&D subsidies, research joint ventures, innovation policy
JEL Classification: L13, O34
October 2005

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89.pdf

Local Public Good Provision, Municipal Consolidation, and National Transfers

Abstract:

We analyze a simple model of local public good provision in a country consisting of a large number of heterogeneous regions, each comprising two districts, a city and a village. When districts remain autonomous and local public goods have positive spillover effects on the neighboring district, there is underprovision of public goods in both the city and the village. When districts consolidate, underprovision persists in the village (and may even become more severe), whereas overprovision of public goods arises in the city as urbanites use their political power to exploit the villagers. From a social welfare point of view, inhabitants of the village have insufficient incentives to vote for consolidation. We examine how national transfers to local governments can resolve these problems.

Keywords: local public goods, municipal consolidation, voting, intergovernmental transfers
JEL Classification: D7, H2, H7, R5
January 2006

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86.pdf

The Theory of Assortative Matching Based on Costly Signals

Abstract:

We study two-sided markets with a finite numbers of agents on each side, and with two-sided incomplete information. Agents are matched assortatively on the basis of costly signals. A main goal is to identify conditions under which the potential increase in expected output due to assortative matching (relative to random matching) is completely offset by the costs of signalling. We also study how the signalling activity and welfare on each side of the market change when we vary the number of agents and the distribution of their attributes, thereby displaying effects that are particular to small markets. Finally, we look at the continuous version of our two-sided market model and establish the connections to the finite version. Technically, the paper is based on the very elegant theory about stochastic ordering of (normalized) spacings and other linear combinations of order statistics from distributions with monotone failure rates, pioneered by R. Barlow and F. Proschan (1966, 1975) in the framework of reliability theory.

December 2005

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85.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

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82.pdf

War with Outsiders Makes Peace Inside

Abstract:

In many situations there is a potential for conflict both within and between groups. Examples include wars and civil wars and distributional conflict in multitiered organizations like federal states or big companies. This paper models such situations with a logistic technology of conflict. If individuals decide simultaneously and independently about the amount of internal conflict, external conflict and production, there is typically either only internal conflict, or only external conflict - but not both. If each group decides collectively how much each member has to put into the external conflict before the members individually decide on the amounts put into the internal conflict and production, groups choose sufficiently high external conflict in order to avoid internal conflict. This is a model of the "diversionary use of force". We also study the optimal number of groups.

Keywords: conflict, war, rent-seeking, hierarchy, federalism, diversion
JEL Classification: D72, D74, H11, H74
December 2005

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75.pdf

Advertising and Conspicuous Consumption

Abstract:

The paper formalizes the intuition that brands are consumed for image reasons and that advertising creates a brand’s image. The key idea is that advertising informs the public of brand names and creates the possibility of conspicuous consumption by rendering brands a signalling device. In a price competition framework, we show that advertising increases consumers’ willingness to pay and thus provide a foundation, based on optimization behavior, for persuasive approaches to advertising. Moreover, an incumbent might strategically overinvest in advertising to deter entry, there might be too much advertising, and competition might be socially undesirable.

Keywords: Advertising, Entry Deterrence, Brands, Conspicuous Consumption, Bertrand Competition, All-Pay Auction
JEL Classification: L12, L15, M37

August 2005

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72.pdf

Regret in Dynamic Decision Problems

Abstract:

The paper proposes a framework to extend regret theory to dynamic contexts. The key idea is to conceive of a dynamic decision problem with regret as an intra-personal game in which the agent forms conjectures about the behaviour of the various counterfactual selves that he could have been. We derive behavioural implications in situations in which payoffs are correlated across either time or contingencies. In the first case, regret might lead to excess conservatism or a tendency to make up for missed opportunities. In the second case, behaviour is shaped by the agent’s self-conception. We relate our results to empirical evidence.

Keywords: Regret, Counterfactual Reasoning, Reference Dependence, Information Aversion
JEL Classification: C72, D11, D81

July 2005

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71.pdf

"Download for Free" - When Do Providers of Digital Goods Offer Free Samples?

Abstract:

In a monopoly setting where consumers cannot observe the quality of the product we show that free samples which are of a lower quality than the marketed digital goods are used together with high prices as signals for a superior quality if the number of informed consumers is small and if the difference between the high and the low quality is not too small. Social welfare is higher, if the monopolist uses also free samples as signals, compared to a situation where he is restricted to pure price signalling. Both, the monopolist and consumers benefit from the additional signal.

Keywords: Digital Goods, Free Samples, Multi-dimensional Signalling
JEL classification: D21, D82, L15
September 2004

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70.pdf

Externalities, Communication and the Allocation of Decision Rights

Abstract:

This paper views authority as the right to undertake decisions that impose externalities on other members of the organization. When only decision rights can be contractually assigned to one of the organization’s stakeholders, the optimal assignment minimizes the resulting inefficiencies by giving control rights to the party with the highest stake in the organization’s decisions. Under asymmetric information, the efficient allocation of authority depends on the communication of private information. In the case of multiple decision areas, divided control rights may enhance organizational efficiency unless there exist complementarities between different decisions.

Keywords: Authority, Decision Rights, Externalities, Incomplete Contracts,
Imperfect Information, Theory of the Firm
JEL Classification: D23, D82, L22, P14

November 2005

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69.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

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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

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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

Black Sheep and Walls of Silence

Abstract:

In this paper we analyze the frequently observed phenomenon that (i) some members of a team (“black sheep”) exhibit behavior disliked by other (honest) team members, who (ii) nevertheless refrain from reporting such misbehavior to the authorities (they set up a “wall of silence”). Much cited examples include hospitals and police departments. In this paper, these features arise in equilibrium. An important ingredient of our model are benefits that agents receive when cooperating with each other in a team. Our results suggest that teams in which the importance of these benefits varies across team members are especially prone to the above mentioned phenomenon.

Keywords: teams, misbehavior, wall of silence, asymmetric information
JEL classification: D82, C73
June 2005

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56.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

A Characterization of the Distributions That Imply Existence of Linear Equilibria in the Kyle-Model

Abstract:

The existence of a linear equilibrium in Kyle's model of market making with multiple, symmetrically informed strategic traders is implied for any number of strategic traders if the joint distribution of the underlying exogenous random variables is elliptical. The reverse implication has been shown for the case in which the random variables are independent and have finite second moments. Here we extend this result to the case in which the underlying random variables are not necessarily independent and their joint distribution is determined by its moments.

Keywords: Market Microstructure, Kyle Model, Linear
JEL Classification: G14, D82
May 2005

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43.pdf

Speculation in Standard Auctions with Resale

Abstract:

In standard auctions with symmetric, independent private value bidders resale creates a role for a speculator—a bidder who is commonly known to have no use value for the good on sale. For second-price and English auctions the efficient value-bidding equilibrium coexists with a continuum of inefficient equilibria in which the speculator wins the auction and makes positive profits. First-price and Dutch auctions have an essentially unique equilibrium, and whether or not the speculator wins the auction and distorts the final allocation depends on the number of bidders, the value distribution, and the discount factor. Speculators do not make profits in first-price or Dutch auctions.

Keywords: standard auctions, speculation, resale, efficiency
JEL Classification: D44
May 2005

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42.pdf

Lobbying contests with endogenous policy proposals

Abstract:

Lobbyists choose what to lobby for. If they can precommit to certain policy proposals, their choice will have an influence on the behavior of opposing lobbyists. Hence lobbyists have an incentive to moderate their policy proposals in order to reduce the intensity of the lobbying contest. This logic has been explored in a number of recent papers. I reconsider the topic with a perfectly discriminating contest. With endogenous policy proposals, there is a subgame perfect equilibrium where the proposals of the lobbyists coincide and maximize joint welfare; moreover, this equilibrium is the only one that survives repeated elimination of dominated strategies. Hence there is no rent dissipation at all. A politician trying to maximize lobbying expenditures would prefer an imperfectly discriminating contest.

Keywords: Interest groups; Endogenous lobbying targets, Voluntary restraint; Polarization
JEL Classification: D72
May 2005

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41.pdf

Interim Information in Long Term Contracts

Abstract:

This paper studies the effectiveness of interim information in reducing inefficiencies in long term relationships. If the interim information is verifiable, it resolves all problems of asymmetric information. Under nonverifiability, the information alleviates the contracting problem only partially and its optimal use depends on the signal’s accuracy and timing. Precise and early signals enable the principal to extract all rents and adjust allocations closer to the first best. Imprecise or late signals affect only future allocations and leaves the agent with a rent. Due to a failure of the revelation principle, the optimal contract under non–verifiability is derived by employing the theory of communication equilibrium.

Keywords: long term contracts, repeated adverse selection, verifiability, revelation
principle;
JEL Classification: D82

April 2005

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40.pdf

Bid Rigging. An Analysis of Corruption in Auctions

Abstract:

In many auctions, the auctioneer is an agent of the seller. This invites corruption. We propose a model of corruption in which the auctioneer orchestrates bid rigging by inviting a bidder to either lower or raise his bid, whichever is more profitable. We characterize equilibrium bidding in first- and second-price auctions, show how corruption distorts the allocation, and why both the auctioneer and bidders may have a vested interest in maintaining corruption. Bid rigging is initiated by the auctioneer after bids have been submitted in order to minimize illegal contact and to realize the maximum gain from corruption.

Keywords: auctions, procurement, corruption, right of first refusal, numerical
JEL Classification: D44
May 2005

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39.pdf

A Proxy Bidding Mechanism that Elicits all Bids in an English Clock Auction Experiment

Abstract:

This paper reconsiders experimental tests of the English clock auction. We point out why the standard procedure can only use a small subset of all bids, which gives rise to a selection bias. We propose an alternative yet equivalent format that makes all bids visible, and apply it to a “wallet auction” experiment. Finally, we test the theory against various alternative hypotheses, and compare the results with those that would have been obtained if one had used the standard procedure. Our results confirm that the standard tests are subject to a significant selection bias.

Keywords: English Clock Auctions, Experimental Economics
JEL Classification: D44, D45, C91
February 2005

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36.pdf

Optimal Information Revelation by Informed Investors

Abstract:

This paper studies the structure of optimal finance contracts in an agency model of outside finance, when investors possess private information. We show that, depending on the intensity of the entrepreneur’s moral hazard problem, optimal contracts induce full, partial, or no revelation of the investor’s private information. A partial or nonrevelation of information is optimal, when it mitigates an undersupply of effort by the entrepreneur due to moral hazard.

Keywords: informed investors, optimal finance contracts, partial information revelation
JEL Classification: G24, D82
January 2005

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34.pdf

Timing of Verification Procedures: Monitoring versus Auditing

Abstract:

This paper studies the strategic effect of a difference in timing of verification in an agency model. A principal may choose between two equally efficient verification procedures: monitoring and auditing. Under auditing the principal receives additional information. Due to a double moral hazard problem, there exists a tension between incentives for effort and incentives for verification. Auditing exacerbates this tension and, consequently, requires steeper incentive schemes than monitoring. Hence, auditing is suboptimal if 1) steep incentives structures are costly to implement due to bounded transfers, or 2) steep incentive schemes induce higher rents due to limited liability. verification in an agency model. A principal may choose between two equally efficient verification procedures: monitoring and auditing. Under auditing the principal receives additional information. Due to a double moral hazard problem, there exists a tension between incentives for effort and incentives for verification. Auditing exacerbates this tension and, consequently, requires steeper incentive schemes than monitoring. Hence, auditing is suboptimal if 1) steep incentives structures are costly to implement due to bounded transfers, or 2) steep incentive schemes induce higher rents due to limited liability.

Keywords: timing of verification, double moral hazard, monitoring, auditi
JEL Classification: D82
January 2005

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33.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

Buried in Paperwork: Excessive Reporting in Organizations

Abstract:

This paper offers an explanation why a principal may demand too much paperwork from a subordinate: Due to limited liability and moral hazard a principal is unable to appropriate all rents. Internal paperwork allows a more accurate monitoring of the agent and enables the principal to appropriate a larger part of the agent's rent. In her decision the principal disregards the agent's cost increase of more internal paperwork. Consequently, the requested amount of internal paperwork may be too high from both the agent's personal point of view and the organization as a whole.

JEL Classification: D23, D82
October 2004

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27.pdf

Deterministic versus Stochastic Mechanisms in Principal–Agent Models

Abstract:

This paper shows that, contrary to what is generally believed, decreasing concavity of the agent’s utility function with respect to the screening variable is not sufficient to ensure that stochastic mechanisms are suboptimal. The paper demonstrates, however, that they are suboptimal whenever the optimal deterministic mechanism exhibits no bunching. This is the case for most applications of the theory and therefore validates the literature’s usual focus on deterministic mechanisms.

Keywords: principal-agent theory, mechanism design, deterministic mechanisms, randomization, bunching.
JEL Classification: D82
September 2004

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26.pdf

Honest Certification and the Threat of Capture

Abstract:

This paper derives conditions under which reputation enables certifiers to resist capture. These conditions alone have strong implications for the industrial organization of certification markets: 1) Honest certification requires high prices that may even exceed the static monopoly price. 2) Honest certification exhibits economies of scale and constitutes a natural monopoly. 3) Price competition tends to a monopolization. The results derive from a general principle of reputation models that favors concentration. This principle implies benefits from specialization and explains specialized certifiers as efficient market institutions that sell reputation as a service to other firms.

Keywords: certification, collusion, bribery, reputation, natural monopoly
JEL Classification: L15, D82, L11
August 2004

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25.pdf

Mediation in Situations of Conflict and Limited Commitment

Abstract:

We study the reasons and conditions under which mediation is beneficial when a principal needs information from an agent to implement an action. Assuming a strong form of limited commitment, the principal may employ a mediator who gathers information and makes non-binding proposals. We show that a partial rev-elation of information is more effective through a mediator than through the agent himself. This implies that mediation is strictly helpful if and only if the likelihood of a conflict of interest is positive but not too high. The value of mediation depends non-monotonically on the degree of conflict. Our insights extend to general models of contracting with imperfect commitment.

Keywords: Contracting, Non-Commitment, Revelation Principle
JEL Classification: D82
June 2004

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24.pdf

Externalities and the Allocation of Decision Rights in the Theory of the Firm

Abstract:

This paper views authority as the right to undertake decisions that have external effects on other members of the organization. Because of contractual incompleteness, monetary incentives are insufficient to internalize these effects in the decision maker’s objective. The optimal assignment of decision rights minimizes the resulting inefficiencies. We illustrate this in a principal–agent model where the principal retains the authority to select ‘large’ projects but delegates the decision right to the agent to implement ‘small’ projects. Extensions of the model discuss the role of effort incentives, asymmetric information and multistage decisions.

Keywords: Authority, Control Rights, Decision Rights, Delegation, Externalities, Incomplete Contracts, Theory of the Firm
JEL Classification: D23, D82, L22
April 2004

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23.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

Cooperative Investments Induced by Contract Law

Abstract:

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

This paper revisits the economic analysis of contract law for a setting of cooperative investments. While Che and Chung (1999) have shown that expectation damages perform rather poorly, the present paper argues that this negative result follows from their impicit assumption of unilateral expectation damages. Yet, the very nature of cooperative investments gives rise to the possibility that both parties may claim expectation damages. It is shown that such a regime of bilateral expectation damages provides the incentives for the first best solution even in a framework of binary choice where, for selfish investments, the traditional overreliance result would hold.

JEL Classification: K12, D62
June 2004

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10.pdf

Gregarious Behaviour of Evasive Prey

Abstract:

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

We model the formation of a herd as a game between a predator and a prey population. The predator receives some information about the composition of the herd when he chases it, but receives no information when he chases a solitary individual. We describe situations in which the herd and its leader are in conflict and in which the leader bows to the herd’s wish but where this is not to the benefit of the herd.

June 2004

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9.pdf

Herding and Contrarian Behavior in Financial Markets - An Internet Experiment

Abstract:

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

We report results of an internet experiment designed to test the theory of informational cascades in financial markets (Avery and Zemsky, AER, 1998). More than 6400 subjects, including a subsample of 267 consultants from an international consulting firm, participated in the experiment. As predicted by theory, we find that the presence of a flexible market price prevents herding. However, the presence of contrarian behavior, which can (partly) be rationalized via error models, distorts prices, and even after 20 decisions convergence to the fundamental value is rare. We also report some interesting differences with respect to subjects’ fields of study. Reassuringly, the behavior of the consultants turns out to be not significantly different from the remaining subjects.

Keywords: informational cascades, herding, contrarians, experiment, internet
JEL Classification: C92, D8, G1
June 2004

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7.pdf

Priority Auctions and Queue Disciplines that Depend on Processing Time

Abstract:

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

We analyze the allocation of priority in queues via simple bidding mechanisms. In our model, the stochastically arriving customers are privately informed about their own processing time. They make bids upon arrival at a queue whose length is unobservable. We consider two bidding schemes that differ in the definition of bids (these may reflect either total payments or payments per unit of time) and in the timing of payments (before, or after service). In both schemes, a customer obtains priority over all customers (waiting in the queue or arriving while he is waiting) who make lower bids. Our main results show how the convexity/concavity of the function expressing the costs of delay determines the queue-discipline (i.e., SPT, LPT) arising in a bidding equilibrium.

May 2004

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5.pdf

Simultaneous inter- and intra-group conflicts

Abstract:

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

This paper models the trade-off between production and appropriation in the presence of simultaneous inter- and intra-group conflicts. The model exhibits a ‘group cohesion effect ’: if the contest between the groups becomes more decisive, or contractual incompleteness between groups becomes more serious, the players devote fewer resources to the intra-group conflict. Moreover, there is also a ‘reversed group cohesion effect’: if the intra-group contests become less decisive, or contractual incompleteness within groups becomes less serious, the players devote more resources to the inter-group contest. The model also sheds new light on normative questions. I derive exact conditions for when dividing individuals in more groups leads to more productive and less appropriative activities. Further, I show that there is an optimal size of the organization which is determined by a trade-off between increasing returns to scale in production and increasing costs of appropriative activities.

Keywords: Conflict, rent-seeking, federalism, hierarchy
JEL Classification: D72, D74, H11, H74
May 2004

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4.pdf

Contracting with Imperfect Commitment and Noisy Communication

Abstract:

Lecture on the first SFB/TR 15 meeting, Gummersbach, July, 18 - 20, 2004
This paper provides an analytical framework for studying principal-agent problems with adverse selection and limited commitment. By allowing the principal to use noisy communication we solve two fundamental problems of contracting with imperfect commitment: First, we identify the relevant incentive constraints by showing that only ‘local’ constraints are binding if the agent’s preferences satisfy a single–crossing property. Second, we show that one can restrict the dimensionality of the message spaces of the communication device to the number of the agent’s types. As we illustrate in an example, these findings allow us to derive the optimal contract by a similar procedure as in contracting problems with full commitment.

Keywords: contract theory, communication, imperfect commitment, adverse selection
JEL Classification: D82, C72
December 2003

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2.pdf