myopic investment decisions and competitive labor markets this paper analyzes an agency problem where managers are able to control an unobservable variable that affects the time distribution of returns on a firm s investments managers have an incentive to select myopic investments in order to convince the labor market that they have relatively high ability the authors demonstrate that if employment terms are determined in competitive labor markets and there are lower bounds on compensations then at the principal s second best contract managers make a myopic investment choice they also characterize the structure of the principal s second best contract and conduct comparative statics at this solution copyright 1994 by economics department of the university of pennsylvania and the osaka university institute of social and economic research association

a two person game of information transmission we consider a statistical decision problem faced by a two player organization whose members may not agree on outcome evaluations and prior probabilities one player is specialized in gathering information and transmitting it to the other who takes the decision this process is modeled as a game qualitative properties of the equilibria are analyzed the impact of improving the quality of available information on the equilibrium welfares of the two individuals is studied better information generally may not improve welfare we give conditions under which it will

can agents be better off with pay caps a popular way to discipline the managers of companies or banks that got into trouble during the recent financial crisis has been to impose caps on managers pay using a small extension of the standard principal agent model we argue that pay caps might serve the opposite purpose because the agent might be better off with a pay cap specifically we show that given a fixed effort level to be implemented the agent s expected utility can be decreasing in an upper bound for the agent s reward the effect of pay caps on the general structure of optimal incentive contracts is also characterized while an improvement of contracting information always helps the principal it might increase or decrease the marginal cost of imposing pay caps

product market competition and managerial slack this article analyzes the effect of product market competition on managerial incentives in contrast to hart 1983a i show that competition may actually exacerbate the incentive problem the difference in results derives from our different assumptions about managerial preferences the importance of assumptions about preferences suggests that we do not yet understand the precise mechanism through which competition affects incentives

the role of options in the resolution of agency problems a comment the aim of the contracting literature in economics is to explain observed contractual arrangements or organizations as minimizing the costs of incentive conflicts in the agency cost literature of financial economics the contractual arrangement at issue is the mix of securities held by inside management of a firm and outside suppliers of capital the ownership structure of the firm in jensen and meckling s 8 terminology in explaining the ownership structure of a corporation jensen and meckling focus on two sources of agency or incentiveconflict costs a the manager s tendency to consume excessive perquisites and b the manager s tendency to invest in prospects of high risk so as to effect an ex post transfer from bondholders to stockholders a recent article in this journal by haugen and senbet 61 examines the role of stock options in resolving these agency problems and claims to show in particular that a call option in the insider portfolio can eliminate the first type of agency costs this article re examines the role of options in the resolution of agency problems we argue in section i that options cannot eliminate the agency problem of excessive perquisite consumption contrary to haugen and senbet the essential point is that unless outside financing can be provided entirely by riskless debt then outsiders must have a residual claim on the net income of the firm in some states of the world outsiders therefore share in the costs of increased perquisite consumption whatever the ownership structure of the firm this negative externality means that excessive perquisite consumption is inevitable the question remains do call options nonetheless have a role in the mitigation of agency costs an insider portfolio consisting only of equity leaves the manager with the same proportion of residual claim in each state of the world we show using a formal principal agent model that the efficient insider s share of profits is relatively high in favorable high profit states of the world insider call options arise as means of transferring residual claim to the manager in favorable states of the world relative to low profit states the basic agency model has been solved in substantial generality by holmstrom 7 and others we employ here a more specific model that draws on the techniques developed by green and kahn 4 and that is an extension to continuous states of the finite state model of sappington 12 the extension allows a simple characterization of the optimal contract a characterization that

equilibrium and agency inadmissible agents in the public agency problem an agency relationship arises when one party the agent takes actions on behalf of another party a principal the theory of agency was first developed in different contexts by robert wilson 1968 1969 a michael spence and richard zeckhauser and the author 1973 1974 and has been extended in a number of different directions steven shavell for example has examined moral hazard issues associated with imperfectly monitoring the agent s effort and milton harris and artur raviv have looked at optimal contract structures this paper takes up some different issues motivated by the desire to study the qualitative properties of equilibrium in markets for agents

imperfect price discrimination and welfare we develop a model in which a monopolist uses differences across consumers in their valuation of time to imperfectly price discriminate though it is customary to analyse price discrimination problems by the calculus of variations after postulating a continuum of types we assume a finite number of types and exploit the geometry and duality of the contract set and the structure of the programming specification we analyse in detail the qualitative properties of the model s solution and show by construction that our results exhaust the implications of the model for equilibrium contract pairs we show that imperfect discrimination is not bounded in welfare terms between perfect discrimination and single price monopoly and that the deadweight loss consumer surplus and output comparisons between single price monopoly and imperfect discrimination are ambiguous

incentives for motivated agents under an administrative constraint consider an agent who has an expertise in producing a non marketable good this good is valued by a single principal and there is a verifiable measure of the agent s performance crucially the agent is intrinsically motivated due to warm glow altruism in addition the agent s budget which is controlled by the principal must not be less than the monetary performance cost faced by the agent this gives rise to a limited liability constraint it also restricts the agent s ability to under report costs in such environment we determine the link between the agent s budget and performance our results come in contrast to the received solution of the principal agent problem and to most in the literature on mission motivated organisations and public services provision

an experimental test of the efficacy of a simple reputation mechanism to solve social dilemmas abstract the evolution of cooperation has been the focus of intense research in the social sciences natural sciences especially biology and even computer science it has long been recognized that the possibility of future consequences is crucial to the emergence of rational cooperation it was thought that random matching was isomorphic to one shot play but kandori 1992 showed that a reputation labeling mechanism can be used to support cooperation in the random matching prisoner dilemma we designed an experiment to test this result we found that while the level of cooperation steadily declined without a reputation mechanism with our color coded reputation mechanism the level of cooperation steadily increased with experience an econometric mixture model consisting of four reputation conditioned strategies as well as a level 0 type was fitted to the data we cannot reject the hypothesis that the majority of subjects used one of these strategies and learned with experience

contract based motivation for keeping records of a manager s reporting and budgeting history this paper analyzes the role of the agent s bankruptcy constraints in multiperiod principal agent models with asymmetric information conditions are provided under which commitment to a long term contract involving n rounds of investment improves upon repetition of n identical single period contracts further when the agent s reservation wage is sufficiently low the optimal contract is always long term keeping records of a manager s history of reporting activity facilitates contracting since optimal contracts may require a link between past reports and future investments over a duration of two or more periods

relational incentive contracts standard incentive theory models provide a rich framework for studying informational problems but assume that contracts can be perfectly enforced this paper studies the design of self enforced relational contracts i show that optimal contracts often can take a simple stationary form but that self enforcement restricts promised compensation and affects incentive provision with hidden information it may be optimal for an agent to supply the same inefficient effort regardless of cost conditions with moral hazard optimal contracts involve just two levels of compensation this is true even if performance measures are subjective in which case optimal contracts terminate following poor performance jel c73 d82 l14

optimal nonuniform prices we consider optimal nonuniform pricing schedules where the price depends upon the amount purchased such schedules are regularly used by public utilities and other services welfare optimal nonuniform prices are related to the theory of optimal uniform prices developed by ramsey we characterize situations in which upward or downward discontinuities in pricing schedules are optimal our results are applicable to a number of related problems including optimal taxation insurance and incentives economic theory has confined most of its attention to markets with uniform prices in which the price per unit charged is invariant to the level of a customer s purchases this focus is warranted when goods are resellable since any attempt to charge nonuniform prices could be circumvented by reselling amongst customers but when goods are not resellable nonuniform prices are not only possible but common public utilities have declining block pricing with lower unit charges for large levels of consumption many agencies providing services including communications transportation even education use two part pricing with a fixed entry or retainer charge and a further charge per unit consumption nonuniform price schedules can be expected to be ever more common as services become a larger fraction of total output the increasing prevalence of nonuniform pricing policies have made them the focus of recent public and economic attention oi 1971 feldstein 1972 and ng and weisser 1974 have examined optimal two part pricing policies leland and meyer 1976 examine block pricing and show by example that optimal welfare policies may require nonuniform prices if zero profit constraints are binding in this paper we consider arbitrary nonuniform pricing policies using variational techniques two part and block pricing schedules are of course special cases of the environment we consider the work most closely related to our examination is the seminal paper by spence 1978 and subsequent analysis by roberts 1979 spence however does not pay explicit attention to the key role played by constraints on optimal pricing schedules roberts considers upward price discontinuities which lead to bunching of consumers at a given level of consumption but not downward price discontinuities which lead to regions in which no consumer chooses to consume gaps bunching or gaps may appear in the optimal price schedule even when underlying demand and cost functions are smooth and well behaved the prevalence of discontinuous pricing schedules e g the block pricing structures of public utilities argues that these questions are of practical as well as theoretical interest

monopoly regulation under asymmetric information prices versus quantities we compare two instruments to regulate a monopoly that has private information about its demand or costs fixing either the price or quantity for each instrument we consider sophisticated screening and simple bunching mechanisms we characterize the optimal mechanisms and compare their welfare performance with unknown demand and increasing marginal costs the sophisticated price mechanism dominates that of quantity whereas the sophisticated quantity mechanism may prevail when marginal costs decrease the simple price mechanism dominates that of quantity when marginal costs decrease but the opposite may arise if marginal costs increase with unknown costs both instruments are equivalent

intermediation and cost determinants of large bank liability composition abstract a translog profit function is estimated for an aggregate of large u s money center banks over 1970 1975 estimates of liability substitution elasticities and own price elasticities of demand are obtained and contrasted with results from earlier partial equilibrium studies statistical analyses led to the rejection of two commonly held propositions in banking 1 that the aggregation of all bank debt to obtain a debt equity ratio is valid and 2 that asset structure can be ignored when liability composition is being determined a mixed full information maximum likelihood estimation technique was used in estimation

wage floors imperfect performance measures and optimal job design we analyze the effects of wage floors on optimal job design in a moral hazard model with asymmetric tasks and imperfect aggregate performance measurement due to cost advantages of specialization assigning the tasks to different agents is efficient a sufficiently high wage floor however induces the principal to dismiss one agent or to even exclude tasks from the production process imperfect performance measurement always lowers profit under multitasking but may increase profit under specialization we further show that variations in the wage floor and the agents reservation utility have significantly different effects on welfare and optimal job design

a reduced form optimal nonlinear income tax problem abstract for a finite population with quasilinear preferences it is shown how mirrlees optimal nonlinear income tax problem can be simplified to a reduced form problem involving only the allocation of the consumption good this result is a finite version of a proposition established in the continuum by s lollivier and j c rochet

implicit contracts with asymmetric information and bankruptcy the effect of interest rates on layoffs this paper develops a model in which a firm writes labour contracts with workers and debt contracts with creditors firms have more information than do the owners of the factors of production and they are also subject to limited liability we show that if the limited liability constraint is binding then the employment level is inefficient relative to a situation of symmetric information the firm is then embedded into a partial equilibrium model in which the real rate of interest is exogenously determined we show that increases in the real rate of interest increase the inefficiency of the optimal employment contract and lead to layoffs in more states of nature than would occur at lower real interest rates recent literature in the area of implicit contracts has shown considerable interest in the assumption of asymmetric information henceforth a i papers by azariadis 1982 green and kahn 1982 and grossman and hart 1981 have all shown that a i will interfere with optimal risk sharing but although these models produce non walrasian outcomes it is not clear that they are capable of explaining the observed variations in employment over the business cycle in the absence of a link between the level of employment and other macroeconomic variables these new versions of contract theory are open to the charge that they are presenting a complicated explanation of frictional unemployment one potential link between variations in output and variations in intertemporal prices is suggested by models which explicitly allow for the possibility of bankruptcy sappington 1983 has shown that bankruptcy will generate inefficient outcomes even between risk neutral agents and farmer 1984 has shown that if sappington type contracts are incorporated into a macroeconomic structure then the resulting model predicts that bankruptcies will vary countercyclically over the business cycle although bankruptcy is important however it is unlikely that bankruptcies alone will account for all of the output loss during a recession the purpose of this paper is to show that the assumptions of a i and limited liability will generate a model in which the employment level is inefficient and in which the magnitude of this inefficiency varies systematically with the expected real rate of interest this model predicts that the observed increase in the incidence of layoffs during recessions is directly attributable to the effects of high interest rates on aggregate supply some evidence of the phenomenon to be explained is presented below

money burning in subjective evaluation and limited liability a case for pay for performance abstract research on subjective evaluation in principal agent models have shown that the optimal contract should give uniform reward with zero money burning at all but the worst performance in a static game involving two independent tasks with only high or low output possible it is shown that when the agent is subjected to limited liability the optimal contract is more likely to exhibit pay for performance full money burning if both tasks yield low outputs partial money burning for mixed performance of low and high outputs and zero money burning following high output in both tasks

limited liability contracts between principal and agent abstract the optimal strategy of the principal is examined in an environment where there are ex post limitations on the maximum penalty that can be imposed on a riskneutral agent contrary to the case in which such limitations are not imposed it is in the principal s interest to deliberately forego the opportunity to induce socially efficient behavior and to instead design a contract that induces the agent to realize an efficient outcome only in the most productive state of nature and perhaps in certain very unproductive states the properties of the contract are examined in detail

modeling the banking firm a survey this paper reports on the status of the literature on micro bank modeling and assesses our understanding of the banking firm s optimal behavior this is no mean task for much has been written on banking broadly defined over the past couple of decades the review is developed in pieces each major subproblem is outlined and the analysis used to deal with the issue explicated this is not the best way to summarize the development of a field it should be immediately recognized one would prefer to have a smooth continuum of development moving the frontier of knowledge evenly through time and across subareas yet this is rarely the way a field develops more likely individual questions attract attention and are the subjects of a substantial number of contributions after a time the field moves on to the new area of interest the banking field is no exception before embarking upon the review however a couple of lines should be devoted to previous attempts there have been essentially three first pyle 1972 analyzes the uncertainty portfolio models at a time when little existed in the literature and hence one finds the review a bit vague and sketchy baltensperger s contributions 1978 1980 are the next serious and rather extensive reviews the quality of these

labor contracts under asymmetric information when workers are free to quit this paper examines the impact of workers ability to quit on the performance of labor contracts between workers and privately informed firms while the need to induce workers to remain with the firm necessarily lowers total welfare the effect on employment levels is to reduce the magnitude of the inefficiency due to asymmetric information whether this inefficiency is under or overemployment the model predicts that employment distortions increase with the strength of lock in effects on workers a prediction which contrasts with the results of efficiency wage models and which may help in empirical testing of labor contract theory

interest rates and bank portfolio adjustments abstract we test empirically to determine if the relation between banks portfolio of assets and liabilities and interest rate is stable several possible causes of instability are considered the econometric techniques employed allow for continuous change in the structure of the empirical model in all cases stability of the model is strongly rejected we find that the portfolio interest rate relationship depends on the level of interest rates and exogenous assets as well as their rate and direction of change

the multiperiod principal agent problem in repeated principal agent models long term contracts can improve on short term contracts only if they commit either principal or agent to a payoff in some future circumstance lower than could be obtained from a short term contract negotiated if that circumstance occurs we show that efficient contracting under moral hazard alone does not require long term commitment from the principal provided a short term contract can punish the agent sufficiently in a sense made precise it requires no commitment from the agent either then linking payoffs in one period to outcomes in previous periods does not improve the tradeoff between incentives and risk sharing

a note on the intracyclical balance sheet behavior of large commercial banks 1972 1978 using a parkin type model this paper tests for the responsiveness of large banks portfolio decisions to exogenous factors over the period 1972 to 1978 based upon aggregate weekly data adjusted for first order autocorrelation and a restricted least squares estimation procedure the empirical results indicate significant differences in behavior i e structural changes over the business cycle previous studies have implicitly assumed that such behavior is constant over the cycle or that differences over the cycle are not significant this research shows that the assumption is untenable and that the differences over the cycle are statistically significant since these patterns vary over the business cycle the differences should be incorporated into models of bank balance sheet behavior to avoid misleading interpretations and implications

an analysis of the principal agent problem most analyses of the principal agent problem assume that the principal chooses an incentive scheme to maximize expected utility subject to the agent s utility being at a stationary point an important paper of mirrlees has shown that this approach is generally invalid we present an alternative procedure if the agent s preferences over income lotteries are independent of action we show that the optimal way of implementing an action by the agent can be found by solving a convex programming problem we use this to characterize the optimal incentive scheme and to analyze the determinants of the seriousness of an incentive problem