optimal contracting and the organization of knowledge we study contractual arrangements that support an efficient use of time in a knowledge intensive economy in which agents endogenously specialize in either production or consulting the resulting market for advice is plagued by informational problems since both the difficulty of the questions posed to consultants and the knowledge of those consultants are hard to assess we show that spot contracting is not efficient because lemons in this case self employed producers with intermediate knowledge cannot be appropriately excluded from the market however an ex ante firm like contractual arrangement uniquely delivers the first best this arrangement involves hierarchies in which consultants are full residual claimants of output and compensate producers via incentive contracts this simple characterization of the optimal ex ante arrangement suggests a rationale for the organization of firms and the structure of compensation in knowledge intensive sectors our findings correspond empirically to observed arrangements inside professional service firms and between venture capitalists and entrepreneurs

efficient mechanisms for bilateral trading we consider bargaining problems between one buyer and one seller for a single object the seller s valuation and the buyer s valuation for the object are assumed to be independent random variables and each individual s valuation is unknown to the other we characterize the set of allocation mechanisms that are bayesian incentive compatible and individually rational and show the general impossibility of ex post efficient mechanisms without outside subsidies for a wide class of problems we show how to compute mechanisms that maximize expected total gains from trade and mechanisms that can maximize a broker s expected profit journal of economic literature classification number 026

financial contracting theory meets the real world an empirical analysis of venture capital contracts we compare the characteristics of real world financial contracts to their counterparts in financial contracting theory we do so by studying the actual contracts between venture capitalists vcs and entrepreneurs the distinguishing characteristic of vc financings is that they allow vcs to separately allocate cash flow rights board rights voting rights liquidation rights and other control rights we describe and measure these rights we then interpret our results in relation to existing financial contracting theories we also describe the interrelation and the evolution across financing rounds of the different rights query 1 query 2

understanding the welfare implications of currency substitution abstract this paper develops a model of endogenous currency substitution where agents decide which purchases will be made with domestic and which with foreign currency in a representative agent economy allowing for this use of alternative means of payments is welfare enhancing the result is an application of ramsey taxation rules by which currency substitution shifts the burden of the inflation tax towards relatively demand inelastic commodities when extending the model to the case in which agents have different productivities we show that inflation has strong income distribution effects with high low income agents benefitting losing when currency substitution is introduced

financial factors in economic development financial factors have been assigned strategic importance in economic development but very different factors have been isolated in the respective experiences in asia unrepressed financial markets in mobilizing saving and allocating investment have been given prominence in latin america the central question is the role of inflationary finance the scope for deficits to enhance growth and increasingly the feedback from high and unstable inflation to poor economic performance this paper reviews and contrasts the two approaches and concludes that the strong claims for the benefits of financial liberalization are not supported by evidence financial factors are important but probably only when financial instability becomes a dominant force the scope for inflationary finance is small and the risks are larger than commonly accepted when hyperinflation takes over and foreign exchange crises disrupt the price system and shorten the economic horizon to a week or a month normal economic development is suspended moreover difficult to reverse capital flight puts savings outside the home economy attention should focus on these extreme cases and explore deeper the thresholds at which financial factors become dominant and the channels through which this occurs superior growth performance in this perspective may be more a reflection of adaptability than financial deepening this abstract was borrowed from another version of this item

optimal trading mechanisms with ex ante unidentified traders abstract we analyze optimal trading mechanisms in an exchange economy where each trader owns some units of a good to be traded and may be either a seller or a buyer depending on the realization of the privately observed valuations the concept of virtual valuation is extended to ex ante unidentified traders the traders virtual valuations now depend on the choice of the trading mechanism and are generally nonmonotonic we show that the trading mechanisms that maximize a broker s expected profit or expected total gains from trade are generalized double auctions which maximize the gains from trade measured in some modified monotonic virtual valuations for the traders the bunching phenomena will be a general feature in these mechanisms we also show that the optimal mechanisms converge towards simple bid ask price mechanisms as the number of participants in the market increases journal of economic literature classification numbers d44 d82

interest rates and currency prices in a two country world abstract this paper is a theoretical study of the determination of prices interest rates and currency exchange rates set in an infinitely lived two country world which is subject both to stochastic endowment shocks and to monetary instability formulas are obtained for pricing all equity claims nominally denominated bonds and currencies and these formulas are related to earlier closely related results in the theories of money finance international trade

learning about the nature of production from equilibrium assignment patterns this paper exploits empirically a key insight from lucas 1978 and rosen 1982 that the organization of production and the distribution of earnings across individuals are jointly determined by the equilibrium assignment of individuals to firms and hierarchical positions we study how different classes of production functions generate alternative equilibrium assignments we then use confidential census data on u s law offices to investigate the form that the production function should take to rationalize earnings patterns in legal services we argue that earnings patterns in this industry are consistent with a production function that is characterized by asymmetric sensitivity to the skill of agents in different organizational positions complementarity between managers and workers skill and scale effects in individual skill

matching problems with expertise in firms and markets when should expertise be shared in markets and when in firms knowledge exchanges in the market involve less information about the quality of the provider s expertise but facilitate good utilization of experts knowledge in a firm management holds soft information about individuals expertise and thus improves on the matching of experts to problems however the usage of experts is not smooth and thus firms experience over or underutilization of experts time thus the trade off between firms and markets is between utilization the market allows for better smoother utilization of knowledge than firms and the quality of matching between problems and problem solvers the market provides less information about experts quality

second opinions and price competition inefficiency in the market for expert advice we consider a market in which an expert must exert costly but unobservable effort to identify the service that meets the consumer s need in our model experts offer competing contracts and the consumer may gather multiple opinions we explore the incentives that a competitive sampling of prices and opinions provides for experts to exert effort and find that there is a tension between price competition and the equilibrium effort in particular the equilibrium fails to realize the second best welfare optimum an intervention that limits price competition via price control increases welfare

the taxation of superstars how are optimal taxes affected by the presence of superstar phenomena at the top of the earnings distribution to answer this question we extend the mirrlees model to incorporate an assignment problem in the labor market that generates superstar effects perhaps surprisingly rather than providing a rationale for higher taxes we show that superstar effects provide a force for lower marginal taxes conditional on the observed distribution of earnings superstar effects make the earnings schedule convex which increases the responsiveness of individual earnings to tax changes we show that various common elasticity measures are not sufficient statistics and must be adjusted upwards in optimal tax formulas finally we study a comparative static that does not keep the observed earnings distribution fixed when superstar technologies are introduced inequality increases but we obtain a neutrality result finding tax rates at the top unaltered

currency prices terms of trade and interest rates a general equilibrium asset pricing cash in advance approach currency prices terms of trade and interest rates a general equilibrium asset pricing cash in advance approach

currency substitution and the real exchange rate the utility maximization approach abstract this paper studies the currency substitution hypothesis with rational expectations in terms of a sidrauski type model where domestic and foreign money enter the utility function it shows that contrary to liviatan 1981 the approach does not necessarily contradict calvo and rodriguez 1977 furthermore the impact of monetary stabilization policy is fully characterized with flexible and pre fixed rates for an extension of dornbusch and mussa 1975 a brief analysis of the optimal quantity of money is also provided

the economics of breakdowns checkups and cures a market in which the owner of a durable good x contracts with an expert for diagnostic and treatment services is studied good x may be in one of three states health disease or failure only experts can determine whether x is healthy or diseased and perform treatment the owner cannot tell whether recommended treatment is really needed this creates an information based demand for health insurance by risk neutral consumers imperfections in the market for spot insurance may give rise to free diagnostic checks strategic procrastination and long term health maintenance agreements

monopoly with incomplete information recent theoretical research on principal agent relationships has emphasized incentive problems that arise when the parties involved are constrained by either asymmetric information or their inability to monitor each other s actions here we concentrate on the former constraint and consider the case of a single principal the monopolist the main contribution is to show that under a separability assumption strong conclusions can be drawn about the nature of optimal incentive schemes although the primary focus is on optimal quantity discounts in a monopolized market the results also shed light on related topics such as optimal income taxation and commodity bundling

a note on small income effects this note provides an alternative sufficient condition for the small income effect result that is first shown by vives small income effects a marshallian theory of consumer surplus and downward sloping demand rev econ stud 54 1 1987 87 103 the condition is stated by ordinal terms only whereas vives assumes cardinal properties of utility representation second as its application we provide a sufficient condition for the preference being asymptotically quasi linear in a two good economy where the second good is a composition of a large number of goods

on the indeterminacy of equilibrium exchange rates in this paper we consider a particular international economic policy regime the laissez faire regime the distinguishing features of which are unrestricted portfolio choice and floating exchange rates and as we show this regime although favored by many economists is not economically feasible it does not have a determinate equilibrium that is an implication of an overlapping generations model more basically it is an implication of the notion that money is wanted only in order to accomplish trades

optimal fiscal and monetary policy in an economy without capital abstract this paper is concerned with the structure and time consistency of optimal fiscal and monetary policy in an economy without capital in a dynamic context optimal taxation means distributing tax distortions over time in a welfare maximizing way for a barter economy our main finding is that with debt commitments of sufficiently rich maturity structure an optimal policy if one exists is time consistent in a monetary economy the idea of optimal taxation must be broadened to include an inflation tax and we find that time consistency does not carry over an optimal inflation tax requires commitment by rules in a sense that has no counterpart in the dynamic theory of ordinary excise taxes the reason time consistency fails in a monetary economy is that nominal assets should from a welfare maximizing point of view always be taxed away via an immediate inflation in a kind of capital levy this emerges as a new possibility when money is introduced into an economy without capital

competition through commissions and kickbacks in markets for retail financial products and health services consumers often rely on the advice of intermediaries to decide which specialized offering best fits their needs product providers in turn compete to influence the intermediaries advice through hidden kickbacks or disclosed commissions motivated by the controversial role of these widespread practices we formulate a model to analyze competition through commissions from a positive and normative standpoint the model highlights the role of commissions in making the advisor responsive to supply side incentives we characterize situations when commonly adopted policies such as mandatory disclosure and caps on commissions have unintended welfare consequences jel d21 d82 d83 g21 l15 l25

inequality and the organization of knowledge since the seminal work of lawrence f katz and kevin m murphy 1992 the study of wage inequality has taken as its starting point a neoclassical constant elasticity of substitution production function using as inputs capital and lowand high skill labor this approach assumes that the organization of production is fixed and determined by a particular specification of technology and it ignores both the source of the interaction between workers and the organizational aspects of this interaction these shortcomings are particularly important in light of growing empirical evidence that points first to the importance of decreases in the cost of processing and communicating information and second to the complementarity between organizational change and adjustments in the distribution of wages e g timothy f bresnahan et al 2002 this paper argues that theories that seek to guide empirical research on these areas must put knowledge and information at the center of the analysis of organizations and link the organizational structure with aggregate variables via equilibrium frameworks in garicano and rossi hansberg 2003 we present a model of this kind it determines the patterns of organization as manifested by the communication and specialization patterns and the implied wage structure that result from different costs of acquiring and communicating information here we present a simple variant of this theory that allows us to focus on one of the main aspects of that framework the sorting of agents into teams and the wage and organizational structure that accompanies that sorting we use this simple model to analyze the changes in organization and wages that result from a very specific type of technological change a reduction in the cost of communicating knowledge or information this model allows us to consider the effect on within class wage inequality and the impact of information technology on the creation and form of organizations e g size distribution of hierarchies however because knowledge is exogenously given and agents cannot invest in learning an important margin of the model in garicano and rossi hansberg 2003 is fixed namely the degree of decentralization or the extent to which problems are solved at lower levels that model allows the simultaneous study of the acquisition of knowledge spans of control and matching in equilibrium moreover it goes beyond the current analysis in that it allows for organizations with an unconstrained number of layers and in that it studies two aspects of the impact of information technology communication technology like here and the technology to acquire knowledge or information e g processing power through cheaper database access

how not to pay for advice a framework for consumer financial protection abstract this paper investigates the determinants of the compensation structure for brokers who advise customers regarding the suitability of financial products our model explains why brokers are commonly compensated indirectly through contingent commissions paid by product providers even though this compensation structure could lead to biased advice when customers are wary of the adviser s incentives contingent commissions can be an effective incentive tool to induce the adviser to learn which specialized product is most suitable for the specific needs of customers if instead customers naively believe they receive unbiased advice high product prices and correspondingly high commissions become a tool of exploitation policy intervention that mandates disclosure of commissions can protect naive consumers and increase welfare however prohibiting or capping commissions could have the unintended consequence of stifling the adviser s incentive to acquire information more vigorous competition benefits consumers and reduces exploitation but firms have limited incentives to educate naive customers

dollarization in post hyperinflationary argentina abstract this paper analyzes the continued dollarization of the argentine economy which experienced a rapid decline in inflation following its hyperinflations of the 1980s first a measure of dollar currency circulating in argentina is developed thereby improving upon previous studies of dollarization and currency substitution that focused on dollar deposit holdings only second cointegration analysis of peso money demand in argentina finds a negative ratchet effect from inflation the reduction in peso money demand attributable to the ratchet mirrors the estimated stock of all dollar assets held domestically by argentine residents consistent with the hypothesis of irreversible dollarization

the moral hazard of budget breaking it has recently been suggested in the agency literature that moral hazard in teams can be dealt with by introducing a third party who breaks the budget balancing constraint and that this facilitates the design of contracts that can sustain the pareto optimum as a perfect nash equilibrium this note offers an explanation for why the use of budget breaking schemes is not so widespread as that of active monitoring despite the fact that such schemes would save the resources expended on supervision the note demonstrates that allowing the budget to be broken introduces the potential for moral hazard on the part of the third party which could render the proposed equilibrium incredible

monetary expansion and real exchange rate dynamics this paper examines the effect of a change in the rate of monetary expansion on the dynamics of the real exchange rate under fully flexible domestic prices and a floating exchange rate the model is similar in structure to an ealier paper by calvo and rodriguez the main difference being that in our model consumers have an infinite planning horizon and long run perfect foresight one of the main findings is that an increase in the rate of monetary expansion has the impact effect of creating a real appreciation of the exchange rate and a deterioration of the balance of payments contrary to the results of calvo and rodriguez

the demand for money in argentina 1978 1987 before and after the austral program in this study a monthly money demand function for argentina is estimated for a period that ends one month before the austral program may 1985 the performance of the traditional econometric approach is compared with the new cointegration approach to time series econometrics the comparison is carried out by a postsample forecast of the demand for money for a period of two years after the stabilization until july 1987 the cointegration approach is found superior to the traditional approach the first produces a relatively stable money demand whereas the second yields an unstable one

when are stabilizations delayed alesina drazen revisited abstract in an influential article alesina and drazen 1991 why are stabilizations delayed american economic review 81 1170 1188 model delay of stabilization as the result of a struggle between political groups supporting reform plans with different distributional implications in this paper we show that ex ante asymmetries in the costs of delay for the groups will reduce the probability of conflict and will lead to a shorter expected delay accurate common information about the cost of delay may lead to no delay at all in an asymmetric conflict a wider divergence in the distributional implications of reform will reduce the probability of conflict but will lead to a longer expected delay we motivate the asymmetric model of delay by reference to latin american episodes of the 1980s

investment moral hazard and occupational licensing i analyse occupational licensing as an input regulation that requires minimum levels of human capital investment by professionals by raising professionals training levels licensing helps alleviate moral hazard problems associated with the provision of high quality services i also consider certification whereby consumers are provided information about professionals training levels i show that licensing and certification tend to benefit consumers who value quality highly at the expense of those who do not licensing may raise total surplus if sellers investments are not observable but is pareto worsening if training levels are observable certification may however lead to excessive investment as a signalling device and thus be pareto inferior to either licensing or to a policy of laissez faire

small income effects a marshallian theory of consumer surplus and downward sloping demand we formalize the marshallian idea that when the proportion of income spent on any commodity is small then the income effects are small if n is the number of goods we show under certain assumptions on preferences and prices that the order of magnitude of the norm of the income derivative of demand is 1 n as a corollary we get that for the case of a single price change the percentage error in approximating the hicksian deadweight loss by its marshallian counterpart goes to zero at least at the rate 1 n and that demand is downward sloping for n large enough

relational incentives and moral hazard in teams this paper studies moral hazard in teams using a model where efforts are promoted via the combination of profit shares and relational contracts the focus is on how these two forms of incentives interact according to the degree of effort observability and the importance of future interaction the optimal allocation of profit shares can range from a wide dispersion across players to a full concentration of shares in the hands of a single player when shares are sufficiently concentrated the corresponding residual claimant can also adopt the role of administering all relational contracts therefore serving as an endogenously chosen principal copyright 2007 wiley blackwell

smallness of a commodity and partial equilibrium analysis partial equilibrium analysis has a conceptual dilemma that its object should be negligibly small in order to be free from income effect but then the consumer does not care for it and the notion of willingness to pay for it does not make sense in the setting of a continuum of commodities we propose a limiting procedure which transforms the general many commodity framework into a partial single commodity framework in the limit willingness to pay for a commodity is established as a density notion and it is shown to be free from income effect this pins down an exact relationship between general equilibrium analysis and partial equilibrium analysis

confidence in domestic money and currency substitution i introduction the prevalence of currency substitution cs that is the demand for foreign money by domestic residents has been endemic in several latin american and east european countries as well as some other parts of the world traditional explanations of the phenomenon tend to focus on its association with high levels of domestic inflation foreign money is a convenient hedge against the erosion of purchasing power over time 1 therefore the degrees of cs experienced by different countries are theorized as the consequences of the different monetary policies in those countries in particular a stabilization policy such as a decrease in domestic inflation should lead to a decline or even the elimination of cs this prediction however has not been observed empirically in several instances decreases in inflation to minimal levels subsequent to episodes of high inflation have not reversed the demand for foreign money the persistence or hysteresis in cs has been the subject of many theoretical and empirical studies 2 on the other hand interestingly a complete and rapid elimination of local currency has been rarely observed even with high levels of domestic inflation some theoretical explanations of the observed irreversibility of cs in the literature have focused primarily on the transactions technology associated with the use of two monies guidotti and rodriguez 1992 argue that there are costs associated with switching from the use of one currency to the other once an economy is dollarized these costs deter the switch back to the use of domestic money after inflation has abated uribe 1997 elaborates a similar model of cs hysteresis in which the transactions costs are endogenous in that they are a decreasing function of the aggregate level of cs in the economy sturzenegger 1997 postulates a model in which inflation instigates financial adaptation i e a move away from domestic money to the use of foreign money or other assets and transactions costs associated with cs are assumed to decline with an increase in the denomination of purchases in such a setting certain sectors of the economy become dollarized and reversion to the use of domestic money subseq uent to a decline in inflation need not occur in more general terms dornbuschet al 1990 characterize this process of financial adaptation as a shift in money demand for every rate of inflation there is now a lower demand for domestic money leading to hysteresis alternative explanations of cs have focused on public perceptions regarding various government policies one argument is that stabilization policies such as those leading to a decline in inflation lack credibility and hence are ineffective in rooting out cs melvin and fenske 1992 propose this as one explanation for the persistence of demand for foreign money in bolivia monetary reform in the late 1980s notwithstanding a similar conclusion is reached in clements and schwartz 1993 however this argument may imply that persistence in cs is in all likelihood a transitory phenomenon the demand for domestic money will rise eventually as stabilization policies earn credibility in tandon and wang 1999 yet another government policy the imposition of costly capital controls is brought to bear on the persistence of cs in an inflationary economy in such an environment cs arises and persists from balancing between the expected cost of capital controls associated with foreign currency and the loss in purchasing power associated with inflationary domestic money the principal contribution of the present article is the incorporation of agents subjective expectations and beliefs as the key determinant underlying the relative demand for domestic and foreign currencies we study a model in which the confidence in domestic money is partial as in weil 1987 and bertocchi and wang 1995 and extend the previous analysis to a two money environment