testing informational assumptions in common value bidding models this paper provides an example of a means of linking mathematical theory laboratory experiments and standard empirical work theory by necessity abstracts from the naturally occurring world and experiments designed to test theory must incorporate the same abstractions on the other hand empirical tests are generally performed on naturallyoccurring data which may not reflect those same abstractions given this possible divergence naturally occurring data should be tested for consistency with theoretical assumptions whenever possible on the basis of standard symmetric bidding theory this paper reports on a preliminary version of such a test for off shore oil bidding data

currency and credit in a private information economy in an environment with private information spatial separation and limited communication a currency like object and more standard named credits can be distinguished the credit objects can be used among agents in an enduring relationship that is among agents with known trading histories whereas the currency like object must be used among relative strangers in this environment collectively determined pareto optimal rules make the level of the currency like object and the mix of currency to named credits responsive to individual needs and to economywide states total indebtedness is determined by the number of lenders that is by preference or demand shocks and the mix of currency to credits is determined by transaction patterns among the agents

state versus federal environmental regulation in a non cooperative monopoly screening model abstract a multiple principal monopoly screening model is presented in which two regulators act as rivals when setting a menu of contracts composed of a two part pricing scheme and design standard state and federal environmental regulation are modeled we show that the firm prefers federal environmental regulation because the design standards are more stringent this preference for stricter control occurs because higher standards generate higher information rents for the firm

characterization of a class of moral hazard adverse selection games abstract studying a principal agent game in which the agent alone observes the state of the world and reports it but the moral hazard is not reducible shows that if the principal uses all signals then no solution exists i e there is no contract that elicits truth telling and motivates the agent to exert effort when the principal does not use signals on the state of the world that seem irrelevant a solution exists in which some of the ex post signals on outcome are not used even though they obey the informativeness condition of holmstrom bell journal of economics 1979 10 74 91

a common agency with incomplete information in the present article i demonstrate that forming a common agency by oligopolistic firms may not be to their advantage if agents have access to private information about their costs bernheim and whinston 1985 1986 pointed out that a common agency allows the firms to sustain the collusive outcome by giving them a vehicle to internalize the externality generated by their pricing or output decisions if agents have access to private information the advantage pointed out by bernheim and whinston may be more than outweighed by the possible existence of an informational disadvantage specifically if the unit costs of different potential agents are correlated the firm may be more successful in extracting the informational rents of its agent if it contracts with an independent agent and not with the same agent as its rival firm when oligopolistic firms contract with independent agents the revenues of one firm reveal implicit information about the unit costs of agents serving competing firms in the same industry however if the unit costs of different agents are correlated revenues also reflect information about the unit cost of the firm s own agent this additional information transmitted by revenues cannot be controlled by the agent s reporting behavior as a result if the firm conditions its agent s payoff upon revenues it can limit the informational rents that this agent can secure due to the existence of private information this possibility of limiting its agent s informational rents is eliminated if the firm contracts with the same agent as its rivals with a common agency the agent can manipulate the reports delivered to all the firms thus reducing the options available to each of them various patterns of agency relationship exist in markets where oligopolistic producers

optimal redistribution and monitoring of labor supply this paper extends the mirrlees 1971 model of optimal non linear income taxation with a monitoring technology that allows the government to verify labor supply at a positive but non infinite cost we analyze the joint determination of the non linear monitoring and tax schedules and the conditions under which these can be implemented monitoring of labor supply reduces the distortions created by income taxation and raises optimal marginal tax rates possibly above 100 the optimal intensity of monitoring increases with the marginal tax rate and the labor supply elasticity our simulations demonstrate that monitoring strongly alleviates the trade off between equity and efficiency welfare gains of monitoring are around 2 8 of total output the optimal intensity of monitoring follows a u shaped pattern similar to that of optimal marginal tax rates our paper can explain why large welfare states optimally rely on work dependent tax credits active labor market policies benefit sanctions and work bonuses in welfare programs

foreign direct investment intra firm trade and ownership structure abstract asymmetric information about true opportunity cost in trade between a multinational and its foreign affiliate can alleviate the hold up problem in foreign direct investment selling shares in the affiliate to locals is also beneficial because it increases the parent multinational s information rent that is protected from a host government s confiscatory taxation

market equilibrium with private knowledge the effect of asymmetric information between buyers and sellers on product quality was first explored by akerlof 1970 in his pathbreaking paper on the market for lemons he showed that if all purchasers have imperfect information on quality then a market for the product may not exist or if it does function it may not be efficient these results have led to a number of papers concerning insurance and labor markets under different assumptions regarding how agents discriminate between products of varying quality see pauly 1974 rothschild and stiglitz 1976 wilson 1977 miyasaki 1977 and spence 1978

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

contracting in strategic situations abstract cooperative games are distinguished from noncooperative games by the ability to form binding pre play agreements the notion of a binding agreement however is ambiguous for two reasons first contracts can be enforced by various provisions for the payment of damages in the event of breach second contracts generally are incomplete not specifying unique actions for each possible state of the world this paper examines the interaction between incompletely specified and enforced pre play contracts and the outcomes that are achieved in 2 player strategic situations comparisons are made among various damage measures for breach of contract

a revelation scheme for allocating organizational resources abstract efficient resource allocation in a hierarchical organization frequently requires top management to obtain information from division managers but division managers may place personal interests above those of the organization and communicate distorted information designing simple and robust optimal game theoretic revelation schemes is difficult instead of making another attempt at this we analyze a project valuation scheme actually used by several us government agencies under certain environments the scheme encourages managers to truthfully reveal the relative benefits of alternative projects while some aspects of these environments do not have nice mathematical properties we argue that they may well represent better characterizations of the way managers actually view their situation

money as the mechanism of exchange abstract the existence and use of money remained an embarrassing puzzle for monetary analysis we observe over man s history that social groups without generally accepted media of exchange exhibit poor survival characteristics most social groups do not use assets or commodities at random in the execution of exchanges one observes that a small subset of assets is dominantly used in transactions these transaction dominating assets are usually referred to as money the literature contains many suggestive attempts to explain the emergence and role of money the classic writers made passing references in somewhat pictorial language to the extension markets and increasing labor productivity induced by the use of a general medium of exchange this idea has never been systematically developed however karl brunner 1971

multi period insurance contracts this paper examines the form of insurance contracts in the presence of asymmetric information about consumers accident probabilities our goal is to understand the adjustment in contract terms as a function of accident histories in a finite horizon model we also compare these adjustments between alternative market structures our principal findings indicate that history dependent insurance contracts serve a useful sorting role individuals who declare themselves low risks to insurance companies face adverse contracturai terms if they subsequently have many accidents these adjustments are strongest in the case of a single insurance seller but are present in the competitive model as well

balanced bayesian mechanisms in the transferable utility case a number of authors have identified conditions on beliefs that guarantee the existence of bayesian incentive compatible mechanisms with balanced transfers we present a new easy to interpret condition and we show that it is strictly more general than all the other conditions found in the literature we also study conditions guaranteeing the bayesian implementability of all social decision rules with balanced budget mechanisms

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

on governing multilateral transactions with bilateral contracts bilateral contracts while neither negotiated nor enforced in an integrated way are nevertheless often interrelated both economically and strategically owing to production or consumption complementarities and to asymmetric information a set of bilateral contracts forms a mechanism with special properties this mechanism forms a contract equilibrium if there is no joint incentive for a supplier and any individual customer unilaterally to alter the terms of their contract if agents preferences are risk neutral in money income and if their private information is independent then there exists a contract equilibrium that implements efficient transactions if in addition preferences are strictly concave and differentiable in goods and services and technologically feasible sets are suitably convex then this equilibrium is essentially unique

domestic profit advantages of multinational firms this study uses confidential corporate data from the u s federal trade commission s line of business p rogram to test if u s multinational firms earn higher rates of profi t on domestic undertakings than do their nonmultinational rivals dom estic profits are regressed on various industry and firm characterist ics including three different measures of multinationality that correspond to industry overall firm and firm by industry classifica tions the evidence suggests that multinationals do have profit advan tages when foreign activities are in the same or related lines of bus iness the effects of foreign trade as a separate influence appear to be much as in previous studies but with richer interpretations copyright 1987 by the university of chicago

optimal contracts with public ex post information abstract we are concerned with the value of public ex post information about a seller s costs to an initially uninformed buyer we derive necessary and sufficient conditions for a public ex post signal s s that is correlated with the risk neutral seller s costs to render the initial information asymmetry inconsequential to the buyer the first best outcome for the buyer is shown to be feasible if 1 the dimension of s is at least that of or 2 the conditional likelihood function of s given is for one of its realizations sj a strictly increasing function of and more concave in than is the seller s cost function

the efficiency of competitive equilibria in insurance markets with asymmetric information abstract this paper addresses the relationship between competitive equilibria and efficient allocations in an insurance market with asymmetric information using the definition of second best efficiency proposed by harris and townsend 1981 for environments characterized by informational assmmetry the efficiency properties of several proposed market equilibria are examined we find an analogue to the first optimality theorem a miyazaki wilson equilibrium always results in a second best allocation

the dynamic structure of optimal debt contracts abstract in a two period model of costly state verification the optimal contract is characterized and shown to exist the optimal contract is interpreted as a bond contract the model extends the result of one period models that the verification region must be a left tail interval to a multi period setting conditions are identified for the optimal contract to exhibit features such as call prepayment option coupon payment or sinking fund the optimality of certain bond covenants such as refinancing covenants and dividends covenants is also studied

optimal environmental regulation under asymmetric information abstract a market model of environmental regulation with interdependent production and pollution abatement costs and heterogeneous firms is developed firms have private information about costs which have a quadratic form firms pursue bayes nash strategies in communication with the regulator the full information optimum cannot be attained unless gains from trade in the product market net of external damages exceed the information rents earned by firms aggregate output and externality levels are lower at the regulated equilibrium than at the full information social optimum

price stabilization as a bonding mechanism in new equity issues abstract underwriters have an incentive to overstate investor interest in order to persuade some investors to purchase shares at a price in excess of their initial estimate of the fair value we show that this incentive is eliminated when the underwriter commits to secondary market price stabilization destroying the underwriter s incentive to overstate interest reduces the total surplus captured by initial investors in initial public offerings further efficiency gains are associated with penalty bid systems that permit the underwriter to make the stabilization commitment selectively price stabilization can thus be viewed as a bonding mechanism that improves the efficiency of the primary equity market

incentive compatible regulation of a foreign owned subsidiary abstract transfer prices are administered charges for intra firm transfers of factors of production for a multinational firm transfer prices for international transfers provide the means to redistribute costs and increase global profits given variations in national tax and profit repatriation policies local regulation of a subsidiary may thus be necessary to limit the welfare costs of strategic transfer pricing prusa journal of international economics 1990 28 155 172 characterizes the welfare maximizing regulations for a monopoly subsidiary that induce the firm to report transfer prices truthfully we show however that it can be more efficient to implement regulations that encourage the firm to misrepresent its true transfer costs

marginal cost of public funds for different tax instruments and government expenditures the marginal cost of public funds that is the size of the direct and indirect excess burden costs for marginal tax revenues is examined in this paper for an open economy with a savings response and using swedish 1979 data the marginal cost of public funds spent on transfer payments is estimated to vary from 1 47 for a distributionally neutral tax on labor and capital to 7 20 for a more progressive tax where average and marginal labor taxes increase by the same rates for changes in the most important tax instrument the marginal cost of public funds varies from 0 98 for expenditures on infrastructure to 2 27 for transfer payments

the effect of taxation on human capital this study finds a significant negative effect of proportional income taxation on human capital of the few earlier studies to address this issue most suggested a negligible effect of taxation on investment in human capital this earlier conclusion is shown to be incorrect by using a model that is more general in several respects than the models used previously

the taxing task of taxing transnationals financial and real investment flexibility tax competition and superior economic information by transnationals both create a rationale for corporate income taxation and limit the effectiveness of such taxation while these factors have led to a variety of transnational tax policies such as deferral double taxation apportionment and trade rules very few of these institutional features have been integrated into tax competition and agency models in this paper i show how the integration of investment flexibility tax competition and agency issues is crucial to our understanding of corporate tax policies

foreign direct investment and host country policies a rationale for using ownership restrictions abstract this paper examines host governments motivation for restricting ownership shares of multinational firms mnfs in foreign direct investment fdi projects an mnf with a productivity advantage is willing to invest in a host country the host government wants to capture the mnf s surplus yet cannot observe it due to the mnf s private information about its firm specific advantage in contrast a joint venture jv partner might observe this surplus depending on its ownership share the host government can alleviate its informational constraints by using ownership restrictions to force a jv this calls into question the wisdom of calls for liberalizing fdi flows by the wholesale elimination of domestic jv requirements we show that the optimal mechanism involves ownership restrictions that decrease as the size of the mnf s firm specific advantage increases

an incentive compatible approach to the transfer pricing problem abstract this paper offers an alternative approach to regulating certain types of transfer pricing if the multinational enterprise s transfer price decision is not regulated it will manipulate the transfer price in order to maximize net global profit traditional approaches argue for ad hoc penalty schedules to mitigate manipulative transfer pricing in contrast this paper offers an incentive compatible approach which explicitly incorporates the informational asymmetries that encourage misreports the model has the desirous feature that the optimal regulatory policy has self enforcing properties that is the firm will find it profit maximizing to report true costs

noncooperative regulation of a nonlocalized externality with a nonlocalized pollution externality different groups bear the costs and benefits of abatement in the case of acid rain these groups are respectively consumers in the midwest and pollutees in the northeast these groups have conflicting interests that are represented respectively by a public utilities commission and an environmental regulator we analyze a model in which the environmental protection agency acting as a von stackelberg leader regulates pollution and the public utility commission regulates the price for a monopolist that has private information about the effectiveness of its abatement alternatives we characterize a noncooperative equilibrium and compare it with a cooperative equilibrium a nonlocalized pollution externality poses special regulatory problems when the benefits and the costs of abatement are borne by distinct groups whose interests are represented by different regulatory agencies a relevant example is acid rain which is believed to be caused in part by coal fired electricity generating plants these emit sulfur dioxide and nitrogen oxide which upon contact with moisture in the atmosphere form acid that falls with rain measures to reduce these emissions are of concern to the residents of the states in which the coal fired generating plants are located because abatement costs increase the prices they pay for electricity a number of plans have been proposed for distributing those costs more broadly but the costs of reducing the emissions of generating plants located in ohio will likely be borne in large part by ohio consumers and utilities while the benefits from abatement will largely be realized by the residents of the northeast and canada the control of a nonlocalized externality such as acid rain raises the issue of the relationship between the environmental regulator the environmental protection agency epa and the public utility commission the former is responsible for achieving an acceptable balance between the damage from pollution and the cost of abatement the latter is responsible for pricing electricity on the basis of the costs of production and pollution control one possibility is that cooperation between the two regulators leads to the joint regulation of emissions and prices cooperation would internalize the conflicting interests and mandates of the regulators but the distributive consequences of the regulatory alternatives inhibit cooperation the public utility commission for example has an interest in avoiding abate

monitoring of performance in organizational contracting the case of defense procurement this paper contains an agency theoretic analysis of procurement contracts in which the government designs optimal linear contracts for a risk averse supplier in the presence of moral hazard private information and imperfect monitoring optimal contracts deviate from first best risk sharing the direction of the deviation depends on the relative severity of the moral hazard and private information problems and on the precision of the monitor in contrast to the usual result in the moral hazard literature the government may in some cases prefer that the effort of the supplier be taxed choice of the precision of the monitor and the categories of costs covered by the monitor are also studied

incentives in academics why is there tenure this paper models ancademic department as an internal labor market the major problem facing the university administration is to ensure that members of its departments are willing to hire the best possible candidates academic tenure is seen to be a necessary condition for this the analysis is also consistent with other aspects of the academic environment including tenure track appointments contract buy outs early retirement plans and when a budget crunch hits the elimination of entire departments the results extend in a simple way to other organizations in which members have an input into overall decisions

contracts and asymmetric information in the theory of the firm abstract this paper extends the coase notation of firms as intermediaries between consumers and input owners to incorporate asymmetric information we show that in some cases it is optimal for consumers to pay a fixed price for a product and to ignore how the firm operates and the profit that it makes if firms have private information that consumers cannot cheaply obtain however we demonstrate that the optimal contract may require constraints on firms internal operations and profits our work provides conditions under which cost plus contracts are optimal and demonstrates when nonprofit firms are the preferred organization structure

planning stochastic shocks and labour contracts of female workers and their welfare implications in this paper we analyse labour contracts for female workers when there are planned shifts or stochastic shocks to their leisure preference which arise as a result of planned or unplanned pregnancy it will be shown that when female workers plan their pregnancy contract firms can induce self selection among workers through a contract that stipulates a wage profile steeper than the spot wage profile so that self selected workers who accept the contract will not quit even though information on shifts in leisure preference is asymmetric first best efficiency can be achieved through self selection when female workers do not plan childbirths however self selection contracts are not possible when the stochastic shocks are realized there will be quits planning is pareto superior to no planning at equilibrium workers will be allocated optimally workers who have low marginal value of home time will join contract firms and make specific investments while those who have high marginal value will seek employment in the walrasian market and make no specific investments some implications of these results are also discussed in the paper

information acquisition in an incomplete information model of business cycle abstract this paper studies the consequences of allowing information acquisition in a version of lucas barro incomplete information model of business cycle we apply the information equilibrium concept to show that an agent s information acquisition is not invariant to fluctuations of price level and that it has a significant effect on the size of output inflation tradeoff using the optimality criteria developed by muench we find that a change in mean money growth rate does not have any real consequences and that a constant money growth rule is superior to any monetary policy that induces all the agents to be fully informed

the economics of earnings manipulation and managerial compensation this article examines managerial compensation in an environment where managers may take a hidden action that affects the actual earnings of the firm when realized these earnings constitute hidden information that is privately observed by the manager who may expend resources to generate an inflated earnings report we characterize the optimal managerial compensation contract in this setting and demonstrate that contracts contingent on reported earnings cannot provide managers with the incentive both to maximize profits and to report those profits honestly as a result some degree of earnings management must be tolerated as a necessary part of an efficient agreement

incentive contracting with asymmetric and imperfect precontractual knowledge abstract the pareto optimal contract between principal and risk neutral agent is analyzed for the case in which the agent s information is initially imperfect but better than that of the principal in contrast to the case where precontractual information is symmetric the final contract between principal and agent will not always guarantee an efficient outcome however in contrast to the case where the agent s information is initially perfect the agent may be unable to command rents from his superior information and the outcome will always be efficient the conditions under which efficient or inefficient outcomes are guaranteed differ qualitatively according to whether the random stete of nature follows a continuous or a discrete distribution journal of economic literature classification numbers 022 026 611

a dual characterization of incentive efficiency we show that incentive efficient allocations in economies with adverse selection and moral hazard problems can be determined as optimal solutions to a linear programming problem and we use duality theory to obtain a complete characterization of the optima our dual analysis identifies welfare effects associated with the incentives of the agents to truthfully reveal their private information because these welfare effects may generate non convexities incentive efficient allocations may involve randomization other properties of incentive efficient allocations are also derived

american taxation of multinational firms publisher summary this chapter discusses the american taxation of multinational firms it is assumed that a multinational firm starts with an existing stock of foreign and domestic investment and seeks the optimal change in its position over the next year as the earnings generated by existing investments are an important source of capital for new investment one cannot ignore the role of the past in shaping the present the chapter presents an analysis that focuses not only on the levels of foreign and domestic investment but also on the financing of that investment it is also assumed that the foreign subsidiary can deduct from its taxable income interest on intrafirm debt as well as royalties head office charges and other such payments for intrafirm services

adverse selection private information and lowballing in insurance markets recent contributions to the adverse selection literature have focused on a multiperiod competitive environment in this setting a clean distinction arises between the predictions of competing models cooper and hayes extend the model of rothschild and stiglitz to multiple periods the result is a self selecting equilibrium characterized by price highballing or systematically overcharging new business kunreuther and pauly suggest that information asymmetries between competing insurance firms render such price quantity policies infeasible their model results in a pooling equilibrium that is characterized by price lowballing or systematically undercharging new business our evidence is consistent with the kunreuther and pauly model and reveals the persistence of adverse selection in the automobile insurance market copyright 1990 by the university of chicago

the welfare costs of deficit finance we analyze the welfare consequences of deficit finance in a general equilibrium model fit to the us economy current spending may be financed with current and or future distortionary taxes the economy is open to international capital flows the welfare costs of financing marginal current spending are substantial and are sensitive to the timing of the required taxes postponing a tax on labor income is advantageous but postponing a tax on asset income is not ricardian equivalence poorly approximates the economy we consider

on imperfect evaluation and earning differentials this paper investigates the relationship between the technology for evaluating performance and optimal contract choice specifically the paper examines the different compensation packages that arise when occupations differ in evaluation technology workers are risk averse work effort is endogenous and there exists asymmetric information in occupations in which it is less difficult to measure output it is shown that compensation is more closely tied to output the implications for work effort the sorting of workers by ability and average compensation are developed analysis of a new data set confirms our predictions concerning earning differentials and wage growth the powerful 1 6 million member national education association and other teacher organizations have traditionally fought the notion of rewarding better teachers with more money arguing that there is no objective way to measure a teacher s competence and that it would lead to favoritism and bad morale time june 20 1983

intrafirm trade arm s length transfer pricing rule and coordination failure abstract this paper demonstrates that uniform imposition of the arm s length principle on transfer pricing leads to coordination failure among countries in terms of economic welfare if the countries trade products in the form of intrafirm transactions by multinational firms mnfs to highlight this implication we first show that imposition of the arm s length principle on an mnf induces it to transfer a product among subordinate divisions at marginal cost i e the competitive price which is consistent with the purpose of the principle nonetheless if regulators in each country impose the principle on mnfs all of the following economic welfare measures decrease compared with the situation where the principle is not imposed 1 consumer welfare in each of the trading countries 2 profit of each mnf and thus 3 total world economic welfare this result indicates that it is possible that enforcement of the principle has no positive effect at all in the world because economic welfare of all economic agents deteriorates when the principle is imposed a numerical analysis demonstrates that this possibility arises in a broad range of circumstances even including the situation where a giant economic world power and a small underdeveloped country mutually trade products in these circumstances an agreement among trading countries that no country imposes the arm s length principle may encourage pareto improvement of the world economy

the design of contracts and remedies for breach in the first part of this article hypothetical contracts providing for all possible uncertain contingencies are considered in the next part contracts providing for only some contingencies are examined and are shown to be advantageous due both to difficulties that could arise in making and enforcing contingent terms and to the presence of implicit substitutes for them in the following major part of the article two of these substitutes for contingent terms are analyzed remedies for breach and the opportunity for renegotiation the existence of both is demonstrated to induce parties to behave approximately as they would under detailed contracts

salesforce compensation plans in environments with asymmetric information in this paper we present a theory of salesforce compensation plans to provide insights into why it may be advantageous for a profit maximizing firm to offer members of its salesforce the opportunity to choose from a menu of compensation plans although such contractual arrangements are not commonly used in the industry they have been introduced and implemented by firms such as ibm and st regis paper as in our previous work on salesforce compensation plans basu lal srinivasan and staelin basu a k r lal v srinivasan r staelin 1985 salesforce compensation plans an agency theoretic perspective marketing sci 4 fall 267 291 we use an agency theory framework in this paper we relax the assumptions of information symmetry and salesforce homogeneity and show the conditions under which it is optimal to offer a menu of compensation plans we also show that even when these assumptions are relaxed there are situations where offering a single plan characterized by basu lal srinivasan and staelin basu a k r lal v srinivasan r staelin 1985 salesforce compensation plans an agency theoretic perspective marketing sci 4 fall 267 291 is still optimal insights gained from the analyses are discussed in the context of an existing compensation scheme

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

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

government debt government spending and private sector behavior a current period tax reduction financed by issuing government debt shifts the timing of tax collection from the current period to the future if the future taxes implied by government debt are not fully perceived and discounted by the private sector there will be a net wealth effect that increases private sector consumption thus reducing capital accumulation and growth if on the other hand the implied future taxes are perceived and discounted by the private sector the current period tax reduction will be used to increase private saving to pay for the future taxes and government debt will be absorbed without any real effects on the economy the effects of government spending financed by current period taxation also depend upon private sector perceptions 2 if the benefits of government spending are ignored private sector consumption will decrease in accordance with the reduction in permanent disposable income to the extent that government spending is on consumption type goods that are perceived as substitutes for privately provided consumption goods there will be a relatively greater reduction in private sector consumption to the extent that government spending is on investment type goods yielding future goods and services that are perceived as substitutes for future privately provided consumption goods there will be a relatively smaller reduction in private sector consumption the standard approach to modeling private sector consumption saving behavior involves a rather asymmetric set of assumptions as to how the private sector perceives the various elements of government fiscal policy 3 current period taxes are assumed to be fully perceived but current period government spending is implicitly assumed to be completely ignored by the private sector in considering permanent personal disposable income the private sector is assumed to be forward looking in its assessment of income and taxation the stock of government debt is nevertheless included as part of the stock of private wealth the implicit assumption associate professor of economics graduate school of business university of chicago 1101 east 58th street chicago il 60637 i thank eugene fama levis kochin michael mussa paul evans and an anonymous referee for helpful comments i am particularly grateful to daniel benjamin for contributing many hours of discussion and laura lahaye who was a research assistant and valuable adviser on earlier drafts the theoretical debate on the burden of the debt has been long standing gerald o driscoll 1977 documents ricardo s nineteenth century position robert barro 1974 reopened the debate by introducing the fundamental issue of intergenerational transfers also discussed in merton miller and charles upton 1974 the empirical side of the debate was initiated by levis kochin s 1974 attempt to test for the effects of deficits on consumption and by martin feldstein s 1974 attempt to test for the effects of social security wealth on consumption other empirical contributions include jess yawitz and laurence meyer 1976 myself 1978 and j earnest tanner 1978 1979 with respect to the effects of government deficits and debt and barro 1978 michael darby 1979 and dean leimer and selig lesnoy 1982 with respect to social security wealth see also interesting recent papers by john seater 1982 who generates detailed tests of the effects of deficits and debt on consumption charles plosser 1982 who explores the effects of government spending and debt shocks on interest rates and feldstein 1982 who attempts tests similar to some in this paper see fn 29 2martin bailey s 1962 1971 development of the effects of government spending on private consumption and aggregate economic activity is the seminal contribution paul david and john scadding 1974 extend bailey s ideas and provide some supporting empirical evidence more recently willem buiter 1977 and myself 1978 developed models based on bailey s earlier work barro 1981 has an interesting paper on related issues see also david aschauer 1982 3the standard approach incorporates fiscal policy through the concept of personal disposable income and by including the stock of government debt as part of personal wealth see for example the empirical specification of albert ando and franco modigliani 1963 which has been the basis of most empirical consumption studies since and feldstein 1974 for one of the more influential papers based on the ando modigliani specification

damage measures and incomplete contracts i present a model of two party contracts that allows for incomplete specification of future states and actions i examine various damage measures under the assumption that courts protect only reasonable reliance expenditures so that parties make efficient reliance choices the expectations damage measure is preferred to the alternative damage measures no matter what the contractual terms are

a mechanism design approach to transfer pricing by the multinational firm abstract this paper is about how multinationals choose transfer prices and optimal production levels in the presence of differential corporate income tax rates and local ownership requirements a key featrure of the model is that there is an asymmetric information problem between a parent and its foreign subsidiary we examine the interaction between ownership structure corporate taxes and bargaining power transfer prices induce underproduction compared to the full information case when the parent has the bargaining ability when bargaining is controlled by the subsidiary overproduction obtains the model is used to illustrate how governmental objectives can be accomplished without direct regulation of the transfer price

a collective tournament abstract traditional tournaments among workers yield suboptimal levels of helping efforts while collective incentives generate free riding or lack incentive compatibility we confront these problems using a tournament between workplaces under fairly restrictive conditions the collective tournament is first best and incentive compatible

a bargaining model with incomplete information about time preferences etude d un jeu de negociation strategique sequentiel avec information incomplete caracterisation d une classe d equilibres sequentiels appeles equilibres sequentiels de negociation et demonstration de l unicite de cet equilibre

do countries compete over corporate tax rates this paper tests whether oecd countries compete with each other over corporate taxes in order to attract investment we develop two models with firm mobility countries compete only over the statutory tax rate or the effective average tax rate while with capital mobility countries compete only over the effective marginal tax rate we estimate the parameters of reaction functions using data from 21 countries between 1983 99 we find evidence that countries compete over all three measures but particularly over the statutory tax rate and the effective average tax rate this is consistent with a belief amongst governments that location choices by multinational firms are discrete we also find evidence of concave reaction functions consistent with the model outlined in the paper

optimal forestry contracts under asymmetry of information in this paper i analyze optimal royalty contracts in forestry when the harvesting firm has private information on the cost of harvesting this infinite horizon forest rotation model with asymmetry of information on the cost parameter results in a dynamic incentive problem depending on whether the costs are correlated over time or not the firm either receives rent or receives no rent associated with the continuation part of the rotation choice i characterize the optimal contract explicitly in both cases i also examine the loss in expected welfare surplus resulting from the use of a linear contract instead of the more general non linear contract

efficient reliance and damage measures for breach of contract this article considers a situation where the buyer or the seller of a good must engage in expenditures on specific capital before the exchange either to prepare to use the product or to prepare to sell it it is assumed that postbreach bargaining is possible and carried out in a cooperative fashion and that buyers and sellers form expectations about the outcome of such bargaining in a specific way without enforceable contracts the potential appropriability of specific rents results in inefficiently low levels of investment three damage measures commonly used to enforce contracts are shown to produce inefficiently high levels of investment and to be pareto ranked from best to worst as follows specific performance expectation damages and reliance damages

structuring international cooperative ventures we examine the effect of bargaining power and informational asymmetry on the design of international cooperative ventures in the presence of restrictions on equity participation and investment when the bargaining advantage rests with the multinational equity participation restrictions can increase the profits to domestic firms and encourage sub optimal investment policies overinvestment occurs when the multinational s bargaining advantage is reinforced by an informational advantage while underinvestment occurs when the domestic firm possesses the informational advantage in contrast when the bargaining advantage rests with the domestic firm equity participation restrictions do not affect investment levels

efficient contracting with reliance and a damage measure this article reexamines the problem of breach of contract studied by shavell 1980 1984 and rogerson 1984 by considering explicitly the incentive problems that arise from asymmetric information and transaction specific investment we derive the optimal contract which consists of variable price and damage payment schedules each of which is set before any private information is observed we show that the optimal contract attains full classical efficiency

deadweight losses and the saving response to a deficit deadweight losses and the saving response to a deficit several recent empirical studies have challenged the conventional wisdom that deficits cause a higher interest rate many economists are however critical of the seemingly implied theoretical justification that every individual fully recognizes the size of the deficit and the extent to which it increases future tax liabilities this paper demosntrates that far weaker information assumptions are needed to obtain an aggregate savings response equal to the deficit a reallocation of deadweight losses causes ricardians to save more than their share of the deficit to keep consumption unaffected allowing for a substantial fractrion of keynesians who save less than their share 1 introduction the saving behavior in the ricardian equivalence theorem is often criticized for relying on perfect foresight e g buchanan 1976 and evans 1985 85 even david ricardo himself rejected what is nowadays termed the ricardian equivalence theorem on grounds that people are not sufficiently aware of future tax liabilities see o driscoll 1977 this paper demonstrates that the saving response obtained by the ricardian equivalence theorem saving oing up by the deficit with a constant interest rate can be obtained with weaker rationality assumptions when deadweight losses associated with nonlump sum taxation are accounted for deadweight losses have been overlooked in the deficit debate possibly because the deadweight loss estimates in the public finance literature were rather small up until a few years ago the first mention of deadweight losses we have found is the brief theoretical discussion of transactions costs in collecting taxes and issuing debt in barro 1974 1109 deficits and welfare is an issue currently debated but the question posed is usually the reverse of the one asked here while we analyze how welfare losses affect the macro consequences of a deficit recent studies have focused on whether deficits increase or decrease welfare for instance both chan 1983 and barsky et al 1986 have studied whether deficits are desirable or not though analyzing how uncertainty of present and future after tax income are affected 1 futher a recent article by hansson and stuart 1987 estimated the losses from labor and capital taxes in a current and a future time period to evaluate the welfare consequences of a reallocation of taxes over time the theoretical argument made in this paper might be viewed as an obvious elaboration of the ricardian equivalence theorem nevertheless given current parameter estimates of deadweight losses the argument turns out to be very important quantitatively a simple illustration will demonstrate that far from everyone perhaps less than half of the population needs to have rational foresight about the deficit in order for a deficit to generate a one to one response in saving ii the behavior of ricardian individuals the effect of taxes altering efficiency and deadweight losses in each of the two time periods the standard ricardian equivalence theorem is arrived at assuming lump sum taxation with no deadweight losses accompanying taxation according to the theorem a deficit has the equivalent effect of current taxation because people anticipate the future tax liability incurred with the deficit these ricardian individuals have no reason to alter their labor supply the production techniques or their consumption pattern all that a deficit therefore results in is an increase in savings that is exactly equal to the deficit how would the analysis change if nonlump sum taxations is allowed for and associated with deadweight losses one shoudl have to analyze which particular tax is cut today and which is raised tomorow when the deficit is generated and how both affect the desired levels of labor suplly consumption etc today and in the future

tax revenue and the marginal cost of public funds in sweden abstract we assess the welfare cost of raising a marginal unit of tax revenue in a balanced budget general equilibrium framework the calculated social cost of an increment of public funds is sensitive to both the specific type of tax increase and the type of public spending used on the margin best guess assumptions on labor supply elasticities yield marginal costs of public funds for different fiscal mixes of between 0 67 and 4 51 at prevailing tax rates in sweden alternative labor supply assumptions well within the range of current estimates substantially affect the results and can imply infinite marginal welfare costs marginal welfare costs are also sensitive to assumptions about both the income and substitution effects of labor supply

optimal regulation of multinationals under collusion this paper analyses the optimal collusion proof mechanism for the regulation of multinational firms mnfs in foreign direct investment fdi projects there is a host country with a profitable investment opportunity either a multinational firm mnf or a local firm lf can undertake this project nonetheless due to its firm specific advantage and the mnf has the potential to create a larger surplus the host government faces an informational constraint such that it cannot observe the extra surplus the mnf can generate using this set up karabay 2010 shows that employing foreign ownership restrictions to force a joint venture jv can help the host government to partially overcome its information disadvantage in this paper we extend karabay 2010 by studying the host government s optimal regulatory policy when the mnf and the lf can collude it turns out collusion imposes no cost on the host government and the expected welfare attained in the absence of collusion can still be secured under collusion

on delegating price authority to a regulated firm this article models a regulatory environment in which the regulated firm possesses better information about demand conditions than does the regulator the regulator would like to tie prices to the firm s private information in a socially optimal way to do so the regulator must induce the firm either truthfully to reveal private information or equivalently unilaterally to set socially optimal prices this is accomplished by assessing lump sum subsidies or taxes that depend in an appropriate way on the prices announced by the firm this mechanism can be reinterpreted as a two part tariff scheme whereby both the service fee and price per unit respond to shifting demand conditions

regulation of multinational firms with two active governments a common agency approach abstract when a government agency imposes cost based taxes regulations on a multinational with private cost information it may initiate countervailing regulations by another of the governments with which the multinational interacts we analyze the problem of optimal regulation of a multinational under incomplete cost information via trade taxes by multiple governments as a problem of common agency with adverse selection by focusing on the game played by the competing governments we characterize the equilibrium trade taxes and show that the non cooperative behavior of the governments not only reduces aggregate national welfare but also reduces firm profits

dynamic labor contracts under asymmetric information abstract this paper discusses the distortion of employment within a two period asymmetric information contracting model in which an exogenous demand shock is serially correlated and is known only to firms the obtained results show that serial correlations of the state of nature can cause not only underemployment but also overemployment even when overemployment never occurs in the context of a static asymmetric information contracting model

a model of the demand for investment banking advising and distribution services for new issues this paper presents a theory of the demand for investment banking advising and distribution services for the case in which the investment banker is better informed about the capital market than is the issuer and the issuer cannot observe the distribution effort expended by the banker the optimal contract under which the offer price decision is delegated to the better informed banker in order to deal with the adverse selection and moral hazard problems resulting from the informational asymmetry and the observability problem is characterized the model demonstrates a positive demand for investment banking advising and distribution services and provides an explanation of the underpricing of new issues an investment banker performs three functions which may be of value to an issuer of new securities underwriting advising and distribution this paper presents a theory of the demand for investment banking advising and distribution services based on an informational asymmetry between an issuer of new securities and an investment banker ultimately a theory of the organization of the financial intermediary industry is required that would predict which firms would use which types of financial intermediaries for which purposes and which firms would raise capital without engaging the services of a financial intermediary only a limited set of such predictions are developed here in the context of a model of a fixedprice offering under a negotiated contract in which the investment banker is

a note on overemployment underemployment in labor contracts under asymmetric information abstract models of labor contracts under asymmetric information may predict either overemployment or underemployment this paper shows that this result depends crucially on whether or not leisure is a normal good if firms are risk neutral

a rationalization of bonuses penalties and kinked payment functions within an agency model abstract the optimal payment schedule of the simplest principal agent problem can be continuous smooth or kinked or semicontinuous depending on the specifications of objective functions of the principal and or of the agent using the nonsmooth mathematical analysis this article determines a mapping from classes of objective functions into classes of optimal payment functions examples provide illustrations

rules or discretion in public sector decision making rules and discretion in public sector decision making are compared in a macroeconomic setting where there is a potential role for an active stabilization policy when the policymaker has private information about nominal shocks the credibility of announcements about the state of nature is shown to depend critically on both the policymaker s preferences over output and inflation and on the institutional setting rules or discretion the issue of rules versus discretion is found to depend on the flexibility lost under a rule relative to the timeinconsistency problem arising under discretion

the design of supply contracts as a problem of delegation we consider the design of a supply contract as a problem of delegation in a buying firm in general the agent who acts on behalf of a principal in the firm cannot be assumed to transform her information in probability estimates like the principal would do possessing the same information in the investigated case of incomplete information the design of contracts is affected by the beliefs about characteristics of the supplier therefore it is important to analyze in which way the expected profit depends on these probabilities in order to find the principal s optimal instruction the best instruction is determined by a trade off between the costs due to the time the principal spends on dealing with the problem and formulating the instructions and the costs due to a suboptimal menu of contracts offered by the agent

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

relying on the information of interested parties we investigate the conventional wisdom that competition among interested parties attempting to influence a decisionmaker by providing verifiable information elicits all relevant information we find that if the decisionmaker is strategically sophisticated and well informed about the relevant variables and about the preferences of the interested party or parties competition may be unnecessary to achieve this result if the decisionmaker is unsophisticated or not well informed competition is not generally sufficient if the interested parties interests are sufficiently opposed however or if the decisionmaker is seeking to advance the parties welfare then competition can reduce or even eliminate the decisionmaker s need for prior knowledge about the relevant variables and for strategic sophistication in other settings only the combination of competition among information providers and a sophisticated skepticism is sufficient to allow effective decisionmaking

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

government and the financing of health care over the past two decades government financing of health care has increased fourteenfold in 1960 prior to the enactment of the medicaid and medicare programs public expenditures on health care were 6 6 billion in 1965 they were 11 billion in 1975 56 billion and by 1979 they had reached 91 4 billion in addition there was a notable shift from state and local to federal outlays in 1960 state and local expenditures were slightly larger than federal expenditures by 1975 federal expenditures were twice the size of state local expenditures the focus of this paper is twofold i will examine both medicare and medicaid and an indirect health care subsidy namely tax expenditures this expenditure consists of losses in federal revenue resulting from tax savings for certain groups of taxpayers allowed by the tax code the logic of calling these revenue losses expenditures is that a reduction in tax liability is equivalent to an expenditure in the same way that a forgiveness of debt is equivalent to a payment congressional budget office in the case of health losses in federal revenue and thus savings to tax payers result from the exclusion of employer paid health insurance premiums from their employees taxable income and from the deductibility of certain medical expenses for the purpose of computing personal income tax liabilities regarding such tax expenditures on health as a major federal program is not a new concept nor is it unique to compare tax expenditures on health with the amounts spent on medicare and medicaid see for example martin feldstein and elizabeth allison eugene steuerle and ronald hoffman ronald vogel the contribution of the present paper is to provide better estimates of employer provided health insurance premiums and therefore tax expenditures and more importantly to show the distributional effects of each of these programs