intertemporal cost dependence in the presence of managerial impatience abstract a multi period agency problem arising in the presence of intertemporal cost dependence is investigated the principal delegates production decisions to a manager who is impatient the manager has private information on the nature of cost dependence that takes the form of an experience effect since the impatient manager would not invest enough to gain experience the principal designs a second best scheme to motivate the manager to increase intertemporal profit for the firm the second best scheme is obtained as a direct revelation mechanism that specifies outputs prices as well as the manager s compensation a significant result is that unlike the first best case impatience is not necessarily a disadvantage with asymmetric information impatience can be exploited to reduce the manager s information rent resulting in preferred outcomes for the principal

strategic responses to automobile emissions control a game theoretic analysis abstract this paper examines the dynamics of standard setting regulation under technological uncertainty and asymmetric information about technological capability a two period model which allows fully strategic action is developed and applied to the regulation of automobile emissions a situation in which standards have been used to force innovation it is found that the initial level of r d activity caused by regulation increases with the intrinsic technical capability of industry this result done not depend on marginal productivities of research that favor high capability types and implies that a poor capability industry will not attempt to compensate for its inability to innovate with increased research activity it is also found that the regulator s ability to induce investment is greater when r d is likely to be unsuccessful

planning under incomplete information and the ratchet effect abstract central planning of production is usually performed under asymmetric information the firm in general has more information about its productive possibilities than the central planner from now on for short cp this justifies the use of incentives schemes in which the cp does not directly fix activity levels casual observation of such existing schemes suggests that the time dimensions is crucial for their working typically the cp revises the incentive scheme over time to take into account the information provided by the firm s performance managers of centrally planned economies as well as economists have long recognized that this revision induces firms to underproduce in order to avoid demanding schemes in the future this is the ratchet effect it is purpose of the present paper to study the ratchet effect under the non commitment assumption which we believe to be more realistic the inadequacy of conceptual tools made if difficult in the past to consider such an assumption now basic research on dynamic games with incomplete information recently resulted in new ideas which look particularly relevant for a theoretical analysis of the problem

second sourcing and the experience curve price competition in defense procurement we examine a dynamic model ofprice competition in defense procurement that incorporates the experience curve asymmetric cost information and the availability of a higher cost alternative system we model acquisition as a two stage process in which initial production is governed by a contract between the government and the developer competition is then introduced by an auction in which a second source bids against the developer for remaining production we characterize the class of production contracts that are cost minimizing for the government and that induce the developer to reveal private cost information when high costs are revealed these contracts result in a credible cutoff of new system production in favor of the still higher cost alternative system

commitment and fairness in a dynamic regulatory relationship this paper considers a multiperiod model of a regulated firm that has stationary private information which may be revealed through performance if it cannot make commitments to future policies the regulator has an incentive to exploit any information the firm reveals and laffont and tirole show that there is no regulatory policy that is separating over any closed interval a fairness arrangement is proposed in which the firm agrees not to quit if in future periods the regulator allows it to earn a nonnegative profit given the type it revealed in earlier periods the properties of such arrangements are studied and an example is presented in which both the firm and the regulator prefer a fairness arrangement to a policy feasible without commitment

a public choice theory of the great contraction further evidence in recent issues of this journal perhaps no other paper has inspired as intense interest as our anderson shughart and tollison 1988 challenge to the friedman schwartz 1963 mistake theory of the great contraction in that article we advanced an hypothesis of fed behavior grounded in the political self interests of the banking system s regulators and their overseers in congress specifically we argued that the fed obtained two important benefits from the massive contraction in the money supply over which it presided between late 1929 and the middle of 1930 first because of the differentially higher failure rates of nonmember banks during this period the proportion of the commercial banking industry under the fed s control increased dramatically the second benefit came in the form of a change in the fed s method of finance which freed the board of governors from the normal congressional budgetary process putting the great contraction in interest group terms we suggested that during 1929 1933 the fed was acting rationally as the agent of congressmen serving on important oversight committees who in turn were representing the interests of the member banks in their states and districts we tested this hypothesis using bank failure rate data across states and found that holding other things equal the failure rates of nonmember banks in the early 1930s were significantly higher in states with representation on the house banking

labor market share contracts when the firm has two variable inputs this paper extends weitzman s analysis of share contracts firstly a second variable input is introduced into a firm s production technology some share contracts give the firm an incentive to reduce worker compensation by manipulating the second variable input this implies that contracts which possess this property cannot support the same long run equilibrium as would be achieved with a wage contract secondly a positively sloped labor supply curve is introduced it is shown that while share contracts reduce involuntary unemployment they may not reduce total unemployment vis a vis wage contracts the paper identifies the factors which determine relative employment variability

incentives in principal agent relationships this article identifies some of the major issues that have been examined in the literature on incentives the article begins by discussing the frictions that lie at the heart of incentive problems next the principal s optimal response to these frictions is explored taking as given the characteristics of the agents with whom the principal interacts in a nonrepeated setting the design of individualized contracts contests and tournaments is analyzed then the principal s task of selecting the best agent is addressed and repeated agency relationships are considered

rate base selection and the structure of regulation this article investigates the role played by rate base valuation rules in the context of rate of return regulation it shows 1 that there is nothing inherently fair about any particular valuation rule 2 that properly interpreted rate bases represent promises of future returns 3 that valuation rules can be fairly selected from a very broad class and 4 that once this is recognized rate of return regulation represents a highly effective and flexible means of avoiding the dynamic consistency problems associated with repeated regulatory reviews in addition the article investigates the nature of optimal rate base valuation rules

the disciplinary role of takeovers this paper presents a theory of the disciplinary role of takeovers based on an explicit model of managerial incentive problems stemming from asymmetric information it is argued that an informed raider can reduce incentive problems by making managerial compensation more sensitive to information unavailable to shareholders the paper also highlights the importance of specifying the source of contractual inefficiencies when analyzing the effect of takeovers on incentives

commitment in procurement contracting limited commitment causes inefficient production and source selecti on in a multistage procurement process wherein the contractor has privat e information about uncertain costs a contractor s limited liability l eads a monopsonist to rely more on quantity distortions to extract rents moreover sequential contracting makes it difficult for the buyer to identify the most efficient supplier copyright 1988 by the editors of the scandinavian journal of economics

the externalities problem of transboundary and persistent pollution abstract this paper deals with implementing the efficient allocation of transboundary and persistent pollution in particular we adapt varian s compensation mechanism varian a solution to the problem of externalities when agents are well informed amer econ rev 85 1994 1278 1293 to cover situations in which pollutants extend to neighboring regions and their effects persist over time the main contribution of this paper is the design of a mechanism that implements in subgame perfect equilibrium the efficient pollution levels in this context

eliminating price supports a political economy perspective abstract this paper characterizes information and politically constrained government programs for eliminating price supports the issues which we examine in this model include i to what extent is it possible to reduce the size of oversubscribed industries in light of the information and political constraints that exist is a complete decoupling of a worker s compensation from her output possible or desirable ii which type of workers as characterized by their skill levels and outside employment opportunities remain in the industry iii which type of worker is harmed by the relocation program which coalitions of workers will oppose the reorganization

procurement policy and contracting efficiency the contracting literature has emphasized the optimality of using certain contracting instruments such as multiple cost observations full commitment self selection and competition a two period procurement model is constructed incorporating all of the instruments and optimal contracts are characterized numerical examples suggest that the marginal benefits of full commitment self selection and multiple cost observations are small while the benefits of competition are larger to obtain some evidence on contracting costs defense contracting is reviewed it indicates that using these instruments is very costly thus calling into question the optimality of using all of the procurement instruments copyright 1993 by economics department of the university of pennsylvania and the osaka university institute of social and economic research association

piece rate incentive schemes this paper uses recent results from incentive theory to study heretofore informal critiques of piece rate compensation schemes the informal critiques are based on the history of failed attempts to install piece rate compensation schemes at the turn of the century the formal analysis emphasizes the importance of information and commitment in contracting the main result is as follows in a work environment characterized by hidden information and a hidden action if neither the firm nor the worker can commit to future behavior then no compensation scheme piece rate or otherwise can induce the worker not to restrict output

the dynamics of incentive contracts the paper studies a simple two period principal agent model in which the principal updates the incentive scheme after observing the agent s first period performance the agent has superior information about his ability the principal offers a first period incentive scheme and observes some measure of the agent s first period performance cost or profit which depends on the agent s ability and unobservable first period effort the relationship is entirely run by short term contracts in the second period the principal updates the incentive scheme and the agent is free to accept the new incentive scheme or to quit the strategies are required to be perfect and updating of the principal s beliefs about the agent s ability follows bayes rule the central theme of the paper is that the ratchet effect leads to much pooling in the first period first for any first period incentive scheme there exists no separating equilibrium second when the uncertainty about the agent s ability is small the optimal scheme must involve a large amount of pooling the paper also gives necessary and sufficient conditions for the existence of partition equilibria and looks at the effect of cost uncertainty

the new deal and modern memory summary economists and other social scientists may never be able to explain fully why the greatdepression happened when it did or why it initially was so severe numerous hypotheses havebeen advanced as we have seen and each of them contributes important insights into thecauses of the macroeconomic calamity in which most of the world was mired in 1929 1933 if however one is forced to adopt a monocausal theory it must center on the actions of america scentral bank which presided over an extraordinary expansion in bank credit in the mid to late1920s and then took the punch bowl off the table for the purposes of this article though the key question is why did the great depressionlast longer in the united states than it did in any other nation the answer as laid out in thenext section is presidential politics 23 there will come seven years of great plenty throughout all the land of egypt but after them will arise seven years offamine and all the plenty will be forgotten in the land of egypt the famine will consume the land genesis 41 29 30 nkjv

short term contracts and long term agency relationships abstract long term contracts are valuable only if optimal contracting requires commitment to a plan today that would not otherwise be adopted tomorrow we show that commitments are unnecessary and hence short term contracts are sufficient if 1 all public information can be used in contracting 2 the agent can acess a bank on equal terms with the principal 3 recontracting takes place with common knowledge about technology and preferences and 4 the frontier of expected utility payoffs generated by the set of incentive compatible contracts is downward sloping at all times

an alternative to a public choice theory of the great contraction in the october 1988 edition of this journal anderson shughart and tollison 1988 4 argued that restrictive monetary policy of the fed in the 1929 1933 period was rational self interested behavior they contend that what friedman and schwartz wrongly interpreted as inept monetary policy was actually the calculated campaign of a bureaucracy bent on consolidating its power base they imply that the federal reserve board of governors in order to purge nonmember banks purposely disregarded policy options that would have greatly reduced bank failures increased the money supply and hastened economic recovery anderson et al hereafter ast their regressions a meaningless mathematical exercise and their public choice interpretation of fed intentions a mirage although the percentage of commercial banks belonging to the fed steadily increased during the great contraction as t s 5 to 1 failure rate ratio is seriously misleading it is based upon a severely limited historical context and misinterpretations of both hazard rates and rates of change

regulation asymmetric information and auditing this article analyzes a model of a regulated firm that is better informed about its cost function than is the regulator by auditing at a cost however the regulator is assumed to be able to observe the realized cost of the firm if the regulator finds that the firm had misrepresented its costs at the time at which prices were set he can order a refund to consumers in the optimal policy the regulator audits when the firm reports for pricing purposes that its costs will be high and orders a refund when the auditfinds that realized costs are lower than anticipated given the original report a separation result that obtains for an important case indicates that the initial pricing decision is independent of the auditing decision the auditing decision however depends on the price that was initially set the optimal auditing strategy is characterized and the nature of the welfare gains are identified the methodology used in the analysis involves the characterization of an equilibrium of a revelation game with an ex post observable

optimal retention in agency problems this paper studies the interaction between a single long lived principal and a series of short lived agents in the presence of both moral hazard and adverse selection we assume that the principal can influence the agents behavior only through her choice of a retention rule this rule is further required to be sequentially rational i e no precommitment is allowed we provide general conditions under which equilibria exist where a the principal adopts a cut off rule under which agents are retained only when the reward they generate exceeds a critical bound and b agents separate according to type with better agents taking superior actions we show that in equilibrium a retained agent s productivity is necessarily declining over time but that retained agents are also more productive on average than untried agents due to selection effects finally we show that for each given type agents of that type are more productive in the presence of adverse selection than when there is pure moral hazard i e when that type is the sole type of agent in the model nonetheless adding uncertainty about agent types cannot benefit the principal except in uninteresting cases

economic theories of the firm past present and future we explore the current state of the theory of the firm with attention to its historical origins answers to the crucial theoretical question of why an organization controlled by a central authority cannot always duplicate the performance of a decentralized organization are presented finally we describe some important current directions in the theory of the firm and point out promising avenues for continuing research

the ruthless fed a critique of the ast hypothesis this paper examines the hypothesis that the great contraction was the result of rational rent seeking by members of the federal reserve system in contrast to the ast hypothesis evidence on the share prices of member banks that survived the contraction suggests that the owners of these banks suffered an absolute decline in real wealth and a decline relative to a broad spectrum of other investment alternatives furthermore monetary surprises had no statistically discernible effect on the share prices of these banks this evidence conflicts with the notion that rational rent seeking would lead the owners of member banks and their bureaucratic conspirators in the federal reserve system to unleash a policy with the goal of contracting the money supply by 35 percent

dynamic regulation design without payments the importance of timing abstract we consider a two period model of optimal regulation of a firm subject to marginal compliance cost shocks the regulator faces an asymmetric information problem the firm knows current compliance costs but the regulator does not both the regulator and the firm are uncertain about future costs in our basic framework the regulator may not offer payments to the firm we show that the regulator can vary the strength of regulation over time to induce the firm to reveal its costs and increase welfare in the optimal mechanism the regulator offers stronger weaker regulation in the first period and weaker stronger regulation in the second period if the firm reports low high compliance costs in the first period low cost firms expect compliance costs to rise in the future and thus prefer weaker regulation in the second period high cost firms expect costs to fall in the future and thus prefer regulation which becomes stricter over time thus the regulator offers the low high cost firms slightly weaker stronger regulation in the second period in exchange for much stronger weaker regulation in the first period thereby timing the regulation if the regulator can make payments then the optimal mechanism to some degree times the regulation as long as a positive marginal cost of funds exists if the marginal cost of funds is high enough then under the optimal mechanism the regulator will not use payments and use our timing mechanism exclusively

using cost observation to regulate firms the paper emphasizes the use of accounting data in regulatory or procurement contracts when the supplier 1 has superior information about the cost of the project and 2 invests in cost reduction the main result states that under risk neutrality the supplier announces an expected cost and is given an incentive contract linear in cost overruns this optimal contract moves toward a fixed price contract as the announced cost decreases an investment choice is then introduced and the use of a rate of return regulation is studied

dynamic incentives and responsibility accounting a comment abstract indjejikian and nanda j accounting and economics 27 1999 177 establish that lack of commitment results in an expected economic loss relative to a long term full commitment contract if there is inter period correlation of performance measures they attribute this loss to a ratchet effect we demonstrate the following first their proposed equilibrium is not sustained unless there is some form of limited commitment second these limited commitment assumptions need not induce a ratchet effect third the ratchet effect is neither necessary nor sufficient for an expected economic loss to occur the loss is due to the principal s inability to commit ex ante to the second period incentive rate

information incentives and organizational mode we examine the choice of organizational mode for a two stage production process wherein cost realizations at each stage are observed only by the producing party when these costs are positively correlated the principal prefers to undertake second stage production herself when the correlation is negative and sufficiently small she will prefer that the agent who performs the first stage also perform the second for large negative correlation either mode might be preferred when costs are uncorrelated the principal is indifferent between modes

asymmetric information incentives and price cap regulation a regulatory incentive mechanism is presented in which the regulated firm has superior information about both cost and demand compared to the regulator the mechanism leads to truthful revelation of the demand function and extracts all rents due to private demand information in a nondistorting way the scheme assumes that the regulator can observe lagged expenditures by the firm this mechanism leads to efficient pricing operating and investment behavior by the firm finally it is shown that the mechanism is closely related to recent proposals for price cap regulation and that under certain assumptions simple modifications of these proposals will lead to the mechanisms discussed herein

optimal nonlinear income taxation with a finite population abstract in the standard optimal income taxation problem tax payments depend only on each consumer s own actions piketty j econ theory 61 1993 23 41 shows that if one individual s tax schedule depends on others actions and the government knows the exact ability distribution it can implement any undistorted allocation as the unique revelation game outcome if some individuals misreveal their types piketty s mechanism may assign infeasible allocations we require that tax schedules must balance the government budget for every possible vector of revelations when individuals reveal their type by simple announcements all undistorted allocations can be still implemented even with off equilibrium feasibility constraints

a public choice theory of the great contraction the conventional chicago wisdom about the great contraction is that it was the result of a massive policy failure according to this view the collapse of the economy was brought about mostly by the fact that the monetary policymakers of the day were more concerned with internal power struggles than with supplying reserves to member banks an explanation which with apologies to professor stigler must have elicited uproarious laughter at the bankers club it has been our purpose in this paper to suggest an alternative theory briefly stated the restrictive monetary policy pursued by the fed from 1929 to 1933 was motivated by the economic interests of member banks the fed s policy produced a massive differential failure rate between member and nonmember banks in which the latter were eliminated at a rate at least five times higher than the former fed member banks faced substantially less competition in the banking market after the house cleaning than before although all banks suffered net losses in the short run in the long run member bank profitability was enhanced by the reduction in the number of nonmember competitors at the same time the fed itself benefitted from a substantial increase in the proportion of the total banking system within its bureaucratic jurisdiction and from a change in its method of finance putting the great contraction in interest group terms we suggested that the fed was acting as the agent of congressmen serving on important oversight committees who in turn were representing the interests of the member banks in their states due to interstate branching restrictions the state is the relevant geographic market within which banks compete we tested this hypothesis using bank failure rate data across states and found that holding other things equal the failure rates of nonmember banks in the early 1930s were significantly higher in states with representation on the house banking and currency committee of course not even friedman and schwartz 1963 299 301 argue that fed policy was the sole direct cause of the great contraction but instead maintain that the fed acted in such a way as to take a relatively severe contraction and turn it into by far the most severe business cycle contraction in the whole of u s history but to the extent that the great contraction was worsened by fed policy and this in turn led to the succession of events called the great depression the latter was a side effect of economically rational interests of federal reserve member banks to say the least this would appear to have been an enormously inefficient method of obtaining the postulated benefits certainly there were other less costly methods available by which member banks could have reduced the number of their nonmember rivals this is perhaps the most difficult problem our theory of the great contraction confronts we can offer two responses first although the literature on the great depression tends to focus on fluctuations in national macroeconomic aggregates e g the money supply unemployment and so on it is clear that the severity of the depression differed radically across states states with relatively large agricultural sectors tended to be especially hard hit suffering the highest rates of unemployment and the most significant numbers of bank failures by contrast states in some other areas most notably new england and the southeast seemed to be less seriously affected we note that in some of our regressions the number of nonmember bank failures was negatively and significantly related to state unemployment rates in 1934 this is certainly not conclusive evidence but it does suggest a pattern of differential costs associated with the great contraction that is the costs of providing benefits to federal reserve member banks in states with representation on the relevant oversight committees may have fallen more heavily on the economies of states not so represented if so this would cast a very different light on the actual costs of these policies to the relevant political decision makers second the potential dilemma in this case is no worse than that encountered in the application of the economic theory of politics to many other kinds of government behavior economists since adam smith have ascribed protectionist trade policies to the influence of special interest groups who benefit modestly at the cost of relatively huge economic inefficiencies many other government actions that might be plausibly explained from an interest group perspective would similarly seem to involve costs to the economy which grossly outweigh the benefits special interests might reasonably expect presumably even in such seemingly extreme cases marginal benefits equal marginal costs to the relevant actors some writers have suggested that the political marketplace in modern democracies is characterized by much larger transactions costs than are normally encountered in ordinary markets see demsetz 1982 this might help explain the seemingly huge discrepancies we observe between apparent concentrated benefits and diffused costs in depression era monetary policy in any event this problem is not peculiar to our theory but is shared by many applications of the interest group model of government it is worth emphasizing that the events we have described do fall into the interest group model s stylized depiction of concentrated benefits versus diffuse costs moreover without having a complete picture of all of the options available to the monetary policymakers we cannot be sure that any of the alternatives was in fact more efficient we do know the path that was chosen and that contrary to the conventional wisdom this path had a rationally motivated interest group basis

regulating a monopolist with unknown costs we consider the problem of how to regulate a monopolistic firm whose costs are unknown to the regulator the regulator s objective is to maximize a linear social welfare function of the consumers surplus and the firm s profit in the optimal regulatory policy prices and subsidies are designed as functions of the firm s cost report so that expected social welfare is maximized subject to the constraints that the firm has nonnegative profit and has no incentive to misrepresent its costs we explicitly derive the optimal policy and analyze its properties in their classic papers dupuit 2 and hotelling 5 considered pricing policies for a bridge that had a fixed cost of construction and zero marginal cost they demonstrated that the pricing policy that maximizes consumer well being is to set price equal to marginal cost and to provide a subsidy to the supplier equal to the fixed cost so that a firm would be willing to provide the bridge this first best solution is based on a number of informational assumptions first the demand function is assumed to be known to both the regulator and to the firm while the assumption of complete information may be too strong the assumption that information about demand is as available to the regulator as it is to the firm does not seem unnatural a second informational assumption is that the regulator has complete information about the cost of the firm or at least has the same information about cost as does the firm this assumption is unlikely to be met in reality since the firm would be expected to have better information about costs than would the regulator as weitzman has stated an essential feature of the regulatory environment i am trying to describe is uncertainty about the exact specification of each firm s cost function in most cases even the managers and engineers most closely associated with production will be unable to precisely specify beforehand the cheapest way to generate various hypothetical output levels because they are yet removed from the production process the regulators are likely to be vaguer still about a firm s cost function 12 p 684 as this observation suggests it is natural to expect that a firm would have better information regarding its costs than would a regulator the purpose of this paper is to develop an optimal regulatory policy for the case in which the regulator does not know the costs of the firm one strategy that a regulator could use in the absence of full information about costs is to give the firm the title to the total social surplus and to delegate the pricing decision to the firm in pursuing its own interests which would then be to maximize the total social surplus the firm would adopt the same marginal cost pricing strategy that the regulator would have imposed if the regulator had

delegation as commitment the case of income tax audits in this article we study the value of delegating authority over income tax audit policy arising from the incompleteness of contracts consider a utilitarian government whose ability to commit is limited to aggregate dimensions of its audit policy as publicly verifiable information about detailed allocations of audit budgets is not available we show that the welfare level associated with the full commitment solution can be attained by delegating authority over audit policy to a manager the latter is offered a simple incentive scheme based only on the aggregate variables which are publicly observable in contrast if the government retains authority direct commitment to these same variables does not allow the full commitment welfare level to be achieved thus despite sharing a common informational basis delegation may perform better than centralized arrangements in the presence of incomplete contracts