repeated moral hazard and contracts with memory the case of risk neutrality we consider a repeated moral hazard problem where both the principal and the wealth constrained agent are risk neutral in each of two periods the agent can exert unobservable effort leading to success or failure incentives provided in the second period act as carrot and stick for the first period so that the effort level induced in the second period is higher after a first period success than after a failure if renegotiation cannot be prevented the principal may prefer a project with lower returns i e a project may be too good to be financed or similarly an agent can be overqualified this article offers a new perspective on dynamic moral hazard problems consider a riskneutral principal who can hire a risk neutral but wealth constrained agent the agent can exert unobservable effort which increases the likelihood of success in the one shot problem there is a well known trade off between effort incentives and rent extraction which leads to a downward distorted effort level compared to the first best solution we extend the standard model by assuming that there is a second period in which the principal can make an investment to continue the project and the agent can again exert unobservable effort it turns out that there are several interesting insights that so far have escaped the literature on repeated moral hazard which was focused on the case of risk averse agents in particular if the principal can commit not to renegotiate the second period incentives can be used to partially circumvent the limited liability constraint in the second period the principal induces the agent to choose a particularly high effort level following a first period success and a particularly low effort level following a first period failure the prospect of a higher second period rent following a first period success motivates the agent to exert more effort in the first period i e rents in the second period act as reward and punishment for the first period it should be emphasized that we assume no technological impact of a first period success or failure on the second period technology nevertheless an optimal dynamic contract exhibits memory hence if an outsider observed today a principal agent pair that was successful and another identical pair that was not successful he would be right to predict that the first pair also is more likely to succeed tomorrow in other words a serial correlation across periods which we sometimes refer to as a hot hand effect is generated endogenously merely based on incentive considerations 2

growth and unemployment this paper analyses the effects of growth on long run unemployment using a search model of equilibrium unemployment where growth arises explicitly from the introduction of new technologies that require labour reallocation for their implementation the analysis uncovers and compares between two competing effects of growth on unemployment the first is a capitalisation effect whereby an increase in growth raises the capitalised returns from creating jobs and consequently reduces the equilibrium rate of unemployment the second is a creative destruction effect whereby an increase in growth reduces the duration of a job match thereby raising the equilibrium level of unemployment both directly by raising the job separation rate and indirectly by discouraging the creation of job vacancies this paper asks the question of how the rate of economic growth affects unemployment in the long run the main consideration that leads us to think that this is an interesting question has to do with the re allocative aspect of growth in the long run faster economic growth must come from a faster increase in knowledge to the extent that the advancement of knowledge is embodied in industrial innovations it is likely to raise the job destruction rate through automation skill obsolescence and the bankruptcy associated with the process of creative destruction in short increased growth is likely to produce an increased rate of job turnover and the search theories of lucas and prescott 1974 and pissarides 1990 imply that an increased rate of job turnover will result in a higher natural rate of unemployment this conclusion is also consistent with the empirical results of davis and haltiwanger 1990 which show that periods of high unemployment tend to be periods of high job turnover at the establishment level it suggests the possibility of a positive longrun tradeoff between growth and unemployment at least over some range there has been relatively little attention paid to our question in the literature on longrun determinants of unemployment for example the recent empirical examination by layard nickell and jackman 1991 of unemployment rates among oecd countries did not even consider the rate of economic growth as a possible explanatory variable this is consistent with the seminal theoretical work of phelps 1968 which implies that the natural rate of unemployment is independent of the rate of productivity growth the only

wall street occupations many finance jobs entail the risk of large losses and hard to monitor effort we analyze the equilibrium consequences of these features in a model with optimal dynamic contracting we show that finance jobs feature high compensation up or out promotion and long work hours and are more attractive than other jobs moral hazard problems are exacerbated in booms even though pay increases employees whose talent would be more valuable elsewhere can be lured into finance jobs while the most talented employees might be unable to land these jobs because they are too hard to manage

contracting with wealth constrained agents we examine how a project owner optimally selects a project operator and motivates him to deliver an essential noncontractible input e g effort when potential operators are privately informed about their limited wealth truthful revelation of wealth is induced by promising a higher probability of operation and if necessary a greater share of realized profit the larger the nonrefundable bond that a potential operator posts the project owner benefits when total wealth is widely dispersed among potential operators under plausible conditions limited knowledge of wealth is not constraining for the project owner

tournaments with midterm reviews in many tournaments investments are made over time the question whether to conduct a review once at the end or additionally at points midway through the tournament is a strategic decision if the latter course is chosen then the designer must establish both a rule for aggregating the results of the different reviews and a rule for determining compensations we first study the case of a fixed exogenously given prize and then extend the analysis to the case where the prize is not fixed but may vary with the tournament s outcome it is shown that 1 it is always optimal to assign a higher weight to the final review 2 this weight increases with the dominance of the first stage effort in determining the final review s outcome when the prize is not fixed the optimal design generates an asymmetric tournament in the second stage that favors the winner of the midterm review

the inflation output trade off with downward wage rigidities the macroeconomic implications of downward nominal wage rigidi ties are analyzed via a dynamic stochastic general equilibrium model featuring aggregate and idiosyncratic shocks a closed form solution for a long run phillips curve relates average output gap to average wage inflation it is virtually vertical at high inflation and flattens at low inflation macroeconomic volatility shifts the curve outwards and reduces output the results imply that stabilization policies play an important role and that optimal inflation may be positive and dif fer across countries with different macroeconomic volatility results are robust to relaxing the wage constraint for example when large idiosyncratic shocks arise jel e23 e24 e31 e63

renegotiating moral hazard contracts under limited liability and monotonicity in a principal agent model with unobservable effort and possible renegotiation contracts are assumed to satisfy two natural restrictions limited liability for the agent and monotonicity of payments for the principal the main result is that if the agent has the renegotiation bargaining power any contract is weakly pareto dominated by a debt contract journal of economic literature classification numbers d820 l140 o261

the ir relevance of real wage rigidity in the new keynesian model with search frictions we explore the role of real wage dynamics in a new keynesian business cycle model with search and matching frictions in the labor market both job creation and destruction are endogenous we show that the model generates counterfactual inflation and labor market dynamics in particular it fails to generate a beveridge curve vacancies and unemployment are positively correlated introducing real wage rigidity leads to a negative correlation and increases the magnitude of labor market flows to more realistic values however inflation dynamics are only weakly affected by real wage rigidity this is because of the presence of labor market frictions which generate long run employment relationships the measure of real marginal cost that is relevant for inflation dynamics via the phillips curve contains a dynamic component that does not necessarily move with real wages

limited liability and incentive contracting with ex ante action choices abstract this article examines a principal agent model of financial contracting in which a risk neutral entrepreneur agent makes an unobservable ex ante effort choice while employing the investment funds of a risk neutral investor principal the key innovation is that the investment contract is subject to statutory liability limits given these liability limits two settings are considered one in which the investor payoff function is also constrained to be monotonically nondecreasing in firm profit and another in which no such monotonic contract constraint is imposed in the former case a standard debt contract is shown to emerge and a first best effort choice is not achieved in the latter setting the optimum is characterized by a live or die payoff function and a first best effort level may or may not be realized

the return of the wage phillips curve the standard new keynesian model with staggered wage setting is shown to imply a simple dynamic relation between wage inflation and unemployment under some assumptions that relation takes a form similar to that found in empirical applications starting with the original phillips 1958 curve and may thus be viewed as providing some theoretical foundations to the latter the structural wage equation derived here is shown to account reasonably well for the comovement of wage inflation and the unemployment rate in the u s economy even under the strong assumption of a constant natural rate of unemployment

productivity and unemployment over the business cycle abstract the low correlation between cyclical unemployment and productivity over the post war period hides a large sign switch in the mid 1980s from significantly negative the correlation became significantly positive using a search model of unemployment with nominal rigidities and variable labor effort i show that technology shocks can generate a positive unemployment productivity correlation whereas non technology shocks i e aggregate demand shocks tend to do the opposite in this context i identify two events that can quantitatively explain the increase in the correlation i a sharp drop in the volatility of non technology shocks in the mid 1980s and ii a decline in the response of productivity to non technology shocks which from procyclical became acyclical in the last 25 years

downward nominal and real wage rigidity survey evidence from european firms downward nominal and real wage rigidity it has been well established that the wages of individual workers react little especially downwards to shocks that hit their employer this paper presents new evidence from a unique survey of firms across europe on the prevalence of downward wage rigidity in both real and nominal terms we analyse which firm level and institutional factors are associated with wage rigidity our results indicate that it is related to workforce composition at the establishment level in a manner that is consistent with related theoretical models e g efficiency wage theory insider outsider theory we also find that wage rigidity depends on the labour market institutional environment collective bargaining coverage is positively related with downward real wage rigidity measured on the basis of wage indexation downward nominal wage rigidity is positively associated with the extent of permanent contracts and this effect is stronger in countries with stricter employment protection regulations

relational contracts limited liability and employment dynamics this paper studies a relational contracting model in which the agent is protected by a limited liability constraint the agent s effort is his private information and affects output stochastically we characterize the optimal relational contract and compare the dynamics of the relationship with that under the optimal long term contract under the optimal relational contract the relationship is less likely to survive and the surviving relationship is less efficient in addition relationships always converge to a steady state under the optimal long term contract but they can cycle among different phases under the optimal relational contract

real and nominal wage rigidities and the rate of inflation evidence from west german micro data the paper examines real and nominal wage rigidities we estimate a switching regime model in which the observed distribution of individual wage changes computed from west german register data for 1976 1997 is generated by simultaneous processes of real nominal or no wage rigidity and measurement error the fraction of workers facing wage increases that are due to nominal but mostly real wage rigidity is substantial the extent of real rigidity rises with inflation whereas the opposite holds for nominal rigidity overall the incidence of wage rigidity which accelerates unemployment growth is most likely minimized in an environment with moderate inflation

pollution claim settlements reconsidered hidden information and bounded payments abstract a principal s production decision imposes a negative externality on an agent the principal may be a pollution generating firm the agent may be a nearby town the principal offers a contract to the agent who has the right to be free of pollution then the agent privately learns the disutility of pollution finally a production level and a transfer payment are implemented suppose there is an upper bound possibly zero on payments that the agent can make to the principal in the second best solution there is underproduction for low cost types while there is overproduction for high cost types in contrast to standard adverse selection models of pollution claim settlements there may thus be too much pollution compared to the first best solution

unemployment and productivity in the long run the role of macroeconomic volatility abstract this paper presents a new empirical regularity between the volatility of productivity growth and long run unemployment for a given level of long run productivity growth a theoretical framework based on asymmetric real wage rigidities is shown to have the potential to rationalize this finding the model tends to fit u s long run unemployment better than a specification based on long run productivity growth only especially during the great moderation and the great recession

authority and incentives in organizations the paper analyzes the choice of organizational structure as solution to the trade off between controlling behavior based on authority rights and minimizing costs for implementing high efforts the analysis includes the owner of a firm a top manager and two division heads if it is more expensive to incentivize the division heads the owner will prefer full delegation of authority to them to replace their high incentive pay by incentives based on private benefits of control in that situation decentralization is optimal given that selfish behavior is more important than cooperation for maximizing returns but concentrated delegation of full authority to a single division head is optimal for cooperation being crucial if however incentivizing the division heads is clearly less expensive than creating incentives for the top manager the owner will choose centralization given that cooperation is the dominating issue but partial delegation if selfish behavior is crucial

peer effects and incentives in a multi agent setting individuals often compare own performance with that of their peers these comparisons influence agents incentives and lead to a noncooperative game even if the agents have to complete independent tasks i show that depending on the interplay of the peer effects agents efforts are either strategic complements or strategic substitutes but the informativeness principle always applies i solve for the optimal monetary incentives that complement the peer effects in case of limited liability the principal may prefer to implement inefficiently large efforts although agents earn positive rents that increase in the respective agent s effort level

wage rigidities and labor market adjustment in europe based on an ad hoc firm level survey on wage and pricing policies conducted in a large number of european countries this study finds that about 60 of firms change base wages once a year with some clustering of wage changes observed in january differences in the frequency of wage changes between firms are mainly attributable to the institutional framework of the labor market in which they operate there is evidence of both nominal and real downward wage rigidity moreover when facing a negative shock european firms prefer to reduce the amount of labor rather than cutting wages among those that decide to cut wages a majority prefers to cut flexible wage components rather than base wages the rigidity of base wages is largely explained by fairness and efficiency considerations jel e24 j30

the incidence of nominal and real wage rigidities in great britain 1978 98 this paper analyzes the extent of rigidities in wage setting in great britain over the 1980s and 1990s our estimation strategy which generalizes the work of altonji and devereux 2000 models the notional wage growth distribution the distribution of nominal wage growth that would occur in the absence of rigidities in pay while allowing for the presence of measurement error in the data the model then allows for the possibility that the nominal wage growth of a fraction of the workforce may be subject to a nominal or real downward rigidity our model suggests that real rigidities in wage setting are more prevalent than nominal rigidities although the incidence of these real wage rigidities has fallen gradually over time if firms cannot cut real wages in response to negative demand shocks they may resort to laying off workers our results support this microfoundation of the wage unemployment phillips curve workers who are more likely to be protected from wage cuts are also more likely to lose their jobs

agency and optimal investment dynamics agency problems limit firms access to capital markets curbing investment firms and investors seek contractual ways to mitigate these problems what are the implications for investment we present a theory of a firm s investment dynamics in the presence of agency problems and optimal long term financial contracts we derive results relating firms investment decisions current and past cash flows firm size capital structure and dividends among the results optimal investment is increasing in current and past cash flow and optimal investment is positively serially correlated over time after controlling for investment opportunities these results hold for a range of agency problems jel g30 g31 g32 g35 d82 d86 d92 copyright 2007 oxford university press

loss aversion and the asymmetric transmission of monetary policy there is widespread evidence that monetary policy exerts asymmetric effects on output over contractions and expansions in economic activity while price responses display no sizeable asymmetry to rationalize these facts we develop a dynamic general equilibrium model where households utility depends on consumption deviations from a reference level below which loss aversion is displayed state dependent degrees of real rigidity and elasticity of intertemporal substitution in consumption generate competing effects on output and inflation contractions face the central bank with higher responsiveness of output to interest rate changes as well as a flatter aggregate supply schedule

sudden stops and phoenix miracles in emerging markets a decade has passed since the salvos from mexico s tequila crisis of 1994 1995 echoed around the financial world since then many more crises have taken place in emerging market economies ems furthermore crises have tended to bunch together bringing to the forefront the systemic nature of these events true every new crisis has its own idiosyncratic features but useful policy lessons must be derived from robust empirical regularities this is the research strategy we have pursued in the last few years we will report on two types of regularities that strike us as highly robust across em crises a sudden stops of capital inflows and b phoenix miracles a sudden stop is a sharp fall in capital inflows relative to their past trajectory sudden stops are not a common feature in developed economies and display a large degree of temporal bunching suggesting that global capital market turmoil acts as a coordinating factor external to ems as shown in section i however balance sheet effects namely the interaction of large changes in the real exchange rate during sudden stops and liability dollarization i e foreign exchange denominated debts are key in influencing the likelihood of a sudden stop thus even though the initial shock is in principle exogenous to the economy whether or not it materializes into a sudden stop depends on domestic financial vulnerabilities on the other hand a phoenix miracle is defined as a case in which output recovers relatively quickly from a sharp collapse with virtually no recovery in credit or capital inflows and a very weak recovery in investment hence the reference to the mythical bird rising from the ashes the existence of phoenix like recoveries suggests that financial frictions play a key role in pushing economies to the abyss from which in some way or another they can crawl back to safe ground by means less than apparent to the conventional observer looking for standard fundamentals and thus may appear miraculous interestingly the great depression of the 1930s shares some of the key features of phoenix miracles in ems but shows salient differences as well that suggest nominal labor market rigidities are not crucial in explaining output collapse in ems understanding these regularities could and we believe does shed light on policies aimed at preventing crises and attenuating their effects

representative consumer s risk aversion and efficient risk sharing rules abstract we study the representative consumer s risk attitude and efficient risk sharing rules in a single period single good economy in which consumers have homogeneous probabilistic beliefs but heterogeneous risk attitudes we prove that if all consumers have convex absolute risk tolerance so must the representative consumer we also identify a relationship between the curvature of an individual consumer s individual risk sharing rule and his absolute cautiousness the first derivative of absolute risk tolerance furthermore we discuss some consequences of these results and refinements of these results for the class of hara utility functions

optimal incentives for sequential production processes i study optimal incentive schemes in organizations where agents perform their tasks sequentially i consider a model in which agents effort decisions are mapped into the probability of the project s success an optimal investment inducing mechanism allocates rewards to agents so as to induce all of them to exert effort in equilibrium at minimal cost to the principal i characterize the unique optimal mechanism in several versions of my benchmark model i also address the problem of allocating individuals with diverse qualifications to different slots of the production process as well as allocating tasks of different importance across different agents copyright 2006 rand

who buys and who sells options the role of options in an economy with background risk abstract in this paper we derive an equilibrium in which some investors buy call put options on the market portfolio while others sell them since investors are assumed to have similar risk averse preferences the demand for these contracts is not explained by differences in the shape of utility functions rather it is the degree to which agents face other non hedgeable background risks that determines their risk taking behavior in the model we show that investors with low or no background risk have a concave sharing rule i e they sell options on the market portfolio whereas investors with high background risk have a convex sharing rule and buy these options journal of economic literature classification numbers d52 d81 g11 g13

convex and decreasing absolute risk aversion is proper proper risk aversion a pivotal concept in the study of behavioral conditions on utility functions states that an undesirable risk can never be made desirable by the presence of an independent risk it is well known that standard risk aversion is sufficient for this concept we show in this short article that convex and decreasing absolute risk aversion is an alternative sufficient condition

the nairu in theory and practice airu stands for the nonaccelerating ine ation rate of unemployment it is beyond dispute that this acronym is an ugly addition to the english language there are however two issues that fail to command consensus among economists which we address in this essay the e rst issue is whether the concept of the nairu is a useful piece of business cycle theory we believe it is and we begin this paper by attempting to explain why in our view the nairu is approximately a synonym for the natural rate of unemployment this concept follows naturally from any theory that says that changes in monetary policy and aggregate demand more generally push ine ation and unemployment in opposite directions in the short run once this short run tradeoff is admitted there must be some level of unemployment consistent with stable ine ation the second issue is why the nairu changes over time and in particular why it fell in the second half of the 1990s this question is more dife cult and the answer is open to debate most likely various factors are at work including demographics and government policies yet one hypothesis stands out as particularly promising e uctuations in the nairu appear related to e uctuations in productivity in the 1970s the nairu rose when productivity growth slowed in the 1990s the nairu fell when productivity growth sped up developing and testing models that explain the links among ine ation unemployment and productivity remains a challenge for students of business cycle theory

renegotiation and optimality in agency contracts we analyse renegotiation in a hidden action principal agent model contract renegotiation offers are made by the agent a refinement is imposed on the principal s beliefs if precisely one action is optimal with respect to both the principal s and the agent s contracts the principal believes that that action has been taken with the refinement imposed perfect bayesian equilibrium allocations are identical to the second best in the classical principal agent model without renegotiation when renegotiation is led by the agent and when equilibria satisfy the refinement equilibrium allocations are ex ante efficient incentive contracting is a common mechanism for promoting ex ante investments and for avoiding ex post opportunistic behaviour in a long term or continuing economic relationship the classical principal agent model holmstrom 1979 grossman and hart 1983 is a natural framework for this class of problem in such a model a risk averse agent performs an action on behalf of a risk neutral principal the agent s action is unobservable and affects the principal s revenue in a random fashion the derivation and characterization of efficient compensation schemes have been the major focus in the principal agent literature generally the incentives to motivate a costly action from the agent take the form of profit sharing the agent s reward is made contingent on his random performance outcomes

measures of per capita hours and their implications for the technology hours debate structural vector autoregressions give conflicting results on the effects of technology shocks on hours the results depend crucially on the assumed data generating process for hours per capita we show that the standard measure of hours per capita and productivity have significant low frequency movements that are the source of the conflicting results hodrick prescott hp filtered hours per capita produce results consistent with those obtained when hours are assumed to have a unit root we show that important sources of the low frequency movements in the standard measure are sectoral shifts in hours and the changing age composition of the working age population when we control for these low frequency components to determine the effect of technology shocks on hours using long run restrictions we get one consistent answer hours decline in the short run in response to a positive technology shock we further extend the analysis by examining the effects of demographic controls on the impulse responses to investment specific technology shocks our results are less conclusive

internal labor markets and worker rents abstract we show that establishing an internal labor market by offering combined contracts across hierarchy levels strictly dominates external recruitment when workers are homogeneous the reason is that only an internal labor market can exploit higher tier rents for incentive provision on lower tiers given unobservable heterogeneity of workers relying on an internal labor market has the further advantage of improving the selection of high ability workers for higher ranks which is complemented by rent based incentive schemes however observable worker heterogeneity gives rise to a trade off between incentive and selection issues and may lead to ports of entry on higher tiers of the hierarchy

the role of shocks and institutions in the rise of european unemployment the aggregate evidence two key facts about european unemployment must be explained the rise in unemployment since the 1960s and the heterogeneity of individual country experiences while adverse shocks can potentially explain much of the rise in unemployment there is insufficient heterogeneity in these shocks to explain cross country differences alternatively while explanations focusing on labour market institutions explain current heterogeneity well many of these institutions pre date the rise in unemployment based on a panel of institutions and shocks for 20 oecd nations since 1960 we find that the interaction between shocks and institutions is crucial to explaining both stylised facts

adverse selection in dynamic moral hazard this paper studies a multiperiod moral hazard problem under two assumptions i contracts are subject to renegotiations ii the agent s action has long term effects the action is also interpreted as a choice of characteristic or type renegotiation proof contracts that implement various actions including random ones are characterized under appropriate conditions the equilibrium involves the principal implementing a random action therefore the equilibrium has standard properties of adverse selection models

moral hazard and limited liability the real effects of contract bargaining abstract i examine the standard assumption in the moral hazard agency literature that the principal has all the bargaining power at the contract offer stage when the agent has limited liability as is often the case in practice the contract changes according to the distribution of bargaining power and consequently so does the agents effort implications of this result are examined

effects of background risks on cautiousness with an application to a portfolio choice problem we provide necessary and sufficient conditions on an individual s expected utility function under which any zero mean idiosyncratic risk increases cautiousness the derivative of the reciprocal of the absolute risk aversion which is the key determinant for this individual s demand for options and portfolio insurance

understanding the soft budget constraint we propose a clarification of the notion of a soft budget constraint a concept widely used in the analysis of socialist transitional and market economies our interpretation is broad enough to embrace most existing approaches to soft budget constraint phenomena and provides a classification of their causes and consequences in light of this interpretation we then review the theoretical literature on the subject and compare it with those on other dynamic commitment problems in economics

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

preservation of more risk averse under expectations abstract the preservation of risk aversion properties of utility functions under expectation operations is of interest in the study of derived utility functions in sequential decision problems and in problems with multiple contemporaneous sources of uncertainty the purpose of this note is to present sufficient conditions for the pratt relation more risk averse to be preserved under expectations

repeated moral hazard the role of memory commitment and the access to credit markets abstract the dynamic dimension introduces new questions in moral hazard models thus the roles of memory and commitment have recently raised a marked interest the goal of this paper is to discuss and clarify the issues at hand and to present some new results we show that two conditions are necessary for the optimal long term contract to be implementable via spot contracts first the long term optimum should be renegotiation proof second spot contracts should provide efficient consumption smoothing we discuss how the availability of credit to the agent affects these two prerequisites we also study the hitherto neglected case in which the repetition of the moral hazard problem generates hidden information at recontracting dates the optimal renegotiation proof contract then implements the minimum effort level unless it involves randomized savings

nominal and real wage rigidity in a friction model abstract nominal wage adjustment in contract data is examined for evidence of nominal and real rigidities a friction model encompassing many special cases is used to analyse data from a rich inflation period

contract renegotiation and coasian dynamics consider a long term relationship between a seller and a buyer whose valuation for a per period service or a durable good is private as trade progresses the valuation will be partially revealed and it may be impossible for the parties to commit ex ante not to take advantage of this we analyse this situation first by supposing that the parties can sign a sequence of short term contracts and secondly by supposing that they can sign a long term contract but cannot commit not to renegotiate it later we find a close relationship in the second case between the optimal long term contract and the non commitment outcome in the standard coasian durable good model our results also have implications for hidden information principal agent models

large risks limited liability and dynamic moral hazard we study a continuous time principal agent model in which a risk neutral agent with limited liability must exert unobservable effort to reduce the likelihood of large but relatively infrequent losses firm size can be decreased at no cost or increased subject to adjustment costs in the optimal contract investment takes place only if a long enough period of time elapses with no losses occurring then if good performance continues the agent is paid as soon as a loss occurs payments to the agent are suspended and so is investment if further losses occur accumulated bad performance leads to downsizing we derive explicit formulae for the dynamics of firm size and its asymptotic growth rate and we provide conditions under which firm size eventually goes to zero or grows without bounds

downward wage rigidity in italy micro based measures and implications using the 1985 99 whip data we find a sizable amount of downward wage rigidity in italy with a prevalence of real over nominal rigidity the results hold when real rigidity is identified either with reference to collective bargaining dispositions or to price inflation consistently with the labour market reforms of the early 1990s downward rigidities have become less important over time with the reduction in real rigidities more than offsetting the rise in nominal rigidities we also find that downward wage rigidities are positively related to labour reallocation and local unemployment rates hinting at the macroeconomic relevance of our estimates

job design with sequential tasks and outcome externalities revisited we revisit job design with sequential tasks and outcome externalities from a different perspective extending schmitz 2013a when two sequential tasks need to be performed by wealth constrained agents the principal can hire only one agent or two different agents when there exists an outcome externality in terms of the fixed cost and such an externality is not too large if the two tasks are conflicting resp synergistic then it is optimal for the principal to hire two different agents resp only one agent when there exists an outcome externality regarding the marginal cost the opposite result holds

unemployment and the business cycle abstract this paper presents a dynamic general equilibrium model where labor effort is imperfectly observable and there is unemployment in equilibrium in contrast to shirking models in the efficiency wage literature detected shirkers are not dismissed instead they face a monetary punishment because they forgo an increase in their compensation estimated versions of the model can generate the high variation in employment and low variation of real wages observed over the business cycle and are consistent with existing qualitative evidence about the responses of the economy to fiscal policy shocks

job matching when employment contracts suffer from moral hazard abstract we consider a job matching model where the relationships between firms and wealth constrained workers suffer from moral hazard specifically effort on the job is non contractible so that parties that are matched negotiate a bonus contract higher unemployment benefits affect the workers outside option the latter is improved for low skilled workers hence they receive a larger share of the surplus which strengthens their effort incentives and increases productivity effects are reversed for high skilled workers moreover raising benefit payments affects the proportion of successful matches which induces some firms to exit the economy and causes unemployment to increase

the firm as the locus of social comparisons standard promotion practices versus up or out we suggest a parsimonious dynamic agency model in which workers have status concerns a firm is a promotion hierarchy in which a worker s status depends on past performance we investigate the optimality of two types of promotion hierarchies i standard promotion practices where agents have a job guarantee and ii up or out in which agents are fired when unsuccessful we show that up or out is optimal if success is difficult to achieve when success is less hard to achieve standard promotion practices are optimal provided the payoffs associated with success are moderate otherwise up or out is again optimal

a theory of financing constraints and firm dynamics there is widespread evidence supporting the conjecture that borrowing constraints have important implications for firm growth and survival in this paper we model a multiperiod borrowing lending relationship with asymmetric information we show that borrowing constraints emerge as a feature of the optimal long term lending contract and that such constraints relax as the value of the borrower s claim to future cash flows increases we also show that the optimal contract has interesting implications for firm dynamics in agreement with the empirical evidence as age and size increase mean and variance of growth decrease and firm survival increases

credit and efficiency in centralized and decentralized economies we study a credit model where because of adverse selection unprofitable projects may nevertheless be financed indeed they may continue to be financed even when shown to be low quality if sunk costs have already been incurred we show that credit decentralization offers a way for creditors to commit not to refinance such projects thereby discouraging entrepreneurs from undertaking them initially thus decentralization provides financial discipline nevertheless we argue that it puts too high a premium on short term returns the model seems pertinent to two issues soft budget constraint problems in centralized economies and differences between anglo saxon and german japanese financing practices

workers trust funds and the logic of wage profiles this paper defines a concept a worker s trust fund which is useful in analyzing optimal age earnings profiles the trust fund represents what a worker loses if dismissed from a job for shirking in considering whether to work or shirk a worker weighs the potential loss due to forfeiture of the trust fund if caught shirking against the benefits from reduced effort this concept is used to show that the implicit bonding in upward sloping age earnings profiles is not a perfect substitute for an explicit up front performance bond or employment fee it is also shown that the second best optimal earnings profile in the absence of an up front employment fee pays total compensation in excess of market clearing in a variety of stylized cases

the unemployment volatility puzzle is wage stickiness the answer i discuss the failure of the canonical search and matching model to match the cyclical volatility in the job finding rate i show that job creation in the model is influenced by wages in new matches i summarize microeconometric evidence and find that wages in new matches are volatile and consistent with the model s key predictions therefore explanations of the unemployment volatility puzzle have to preserve the cyclical volatility of wages i discuss a modification of the model based on fixed matching costs that can increase cyclical unemployment volatility and is consistent with wage flexibility in new matches

long term short term and renegotiation on the value of commitment in contracting spot contracting generally involves efficiency losses relative to long term contracting it is proved here that short term contracting and renegotiation allow to achieve long run efficiency when transfers are not limited objectives are conflicting and no relevant asymmetric information appears at recontracting dates this last assumption excludes adverse selection but not moral hazard when technologies and preferences are time separable copyright 1990 by the econometric society

how strong is the macroeconomic case for downward real wage rigidity we explore the existence of downward real wage rigidity drwr at the industry level based on data from 19 oecd countries for the period 1973 1999 the results show that drwr compresses the distributions of industry wage changes overall as well as for specific geographical regions and time periods but there are not many real wage cuts that are prevented more important however drwr attenuates larger real wage cuts thus leading to higher real wages there is stronger evidence for downward nominal wage rigidity than for drwr real wage cuts are less prevalent in countries with strict employment protection legislation and high union density

decentralization and collusion abstract we consider a model where agents work in sequence on a project share information not available to the principal and can collude due to limited liability the coase theorem does not apply the distribution of surplus among the agents is therefore an important control variable for the principal which gives us a theory of how to delegate in an organization subject to moral hazard the optimal distribution of surplus can always be achieved by delegating in the right way decentralization without using message games journal of economic literature classification numbers d23 d82 l14 l22

the impact of tfp growth on steady state unemployment theoretical predictions of the impact of total factor productivity tfp growth on unemployment are ambiguous and depend on the extent to which new technology is embodied in new jobs we evaluate a model with embodied and disembodied technology capitalization and creative destruction effects in econometric estimates with a panel of industrial countries we find a large negative impact of tfp growth on unemployment which implies that embodied technology and creative destruction play no role in the steady state dynamics of unemployment capitalization effects explain some of the estimated impact but a part remains unexplained

state dependence in labor market fluctuations this paper documents state dependence in labor market uctuations using a threshold vector autoregression model tvar we establish that the unemployment rate the job separation rate and the job finding rate exhibit a larger response to productivity shocks during periods with low aggregate productivity a diamond mortensen pissarides model with endogenous job separation and on the job search replicates these empirical regularities well we calibrate the model to match the standard deviation of the job transition rates explained by productivity shocks in the tvar and show that the model explains 88 percent of the state dependence in the unemployment rate 76 percent for the separation rate and 36 percent for the job finding rate the key channel underpinning state dependence in both job separation and job finding rates is the interaction of the firm s reservation productivity level and the distribution of match specific idiosyncratic productivity results are robust across several variations to the baseline model

optimal long term financial contracting we develop an agency model of financial contracting we derive long term debt a line of credit and equity as optimal securities capturing the debt coupon and maturity the interest rate and limits on the credit line inside versus outside equity dividend policy and capital structure dynamics the optimal debt equity ratio is history dependent but debt and credit line terms are independent of the amount financed and in some cases the severity of the agency problem in our model the agent can divert cash flows we also consider settings in which the agent undertakes hidden effort or can control cash flow risk

renegotiation of sales contracts this paper studies moral hazard contracts that may be renegotiated after an agent chooses an unobservable effort unlike in previous models a contract here contains only one compensation scheme and the agent has all the bargaining power in the renegotiation stage using a relatively weak forward induction refinement all equilibria are shown tb be second best efficient renegotiation occurs in every equilibrium if the effort set is rich the only equilibrium initial contract is a sales contract i e a scheme which sells the project to the agent this captures the idea that a party the principal who has an inherently weak renegotiation position will sometimes insist on a simple initial contract

when to fire a ceo optimal termination in dynamic contracts abstract existing models of dynamic contracts impose that it is both optimal and feasible for the contracting parties to bind themselves together forever this paper introduces optimal termination in dynamic contracts we modify the standard dynamic agency model to include an external labor market which upon the dissolution of the contract allows the firm to return to the labor market to seek a new match under this simple closure of the model two types of terminations emerge under one scenario the agent is fired after a bad output and he becomes too poor to be punished effectively under the second scenario the agent is forced out after a good output and he becomes too expensive to motivate

minimum wages and excessive effort supply abstract it is well known that in static models minimum wages generate positive worker rents and consequently inefficiently low effort we show that this result does not necessarily extend to a dynamic context the reason is that in repeated employment relationships firms may exploit workers future rents to induce excessively high effort

two illustrations of the quantity theory of money breakdowns and revivals by extending his data we document the instability of low frequency regression coefficients that lucas 1980 used to express the quantity theory of money we impute the differences in these regression coefficients to differences in monetary policies across periods a dsge model estimated over a subsample like lucas s implies values of the regression coefficients that confirm lucas s results for his sample period but perturbing monetary policy rule parameters away from the values estimated over lucas s subsample alters the regression coefficients in ways that reproduce their instability over our longer sample jel c51 e23 e31 e43 e51 e52 robert e lucas jr 1980 used near unit slopes of univariate regressions of moving averages of inflation and interest rates on money growth for the united states for the period 1953 1977 to illustrate two central implications of the quantity theory of money that a given change in the rate of change in the quantity of money induces i an equal change in the rate of price inflation and ii an equal change in nominal rates of interest lucas said that those two quantity theoretic propositions

structural changes in the us economy is there a role for monetary policy this paper investigates the contribution of monetary policy to the changes in output growth and inflation dynamics in the us we identify a policy shock and a policy rule in at ime varying coefficients var using robust sign restrictions the transmission of policy shocks has been relatively stable the variance of the policy shock has decreased over time but policy shocks account for a small fraction of the level and of the variations in inflation and output growth volatility and persistence we find little evidence of a significant increase in the long run response of the interest rate to inflation a more aggressive inflation policy in the 1970s would have produced large output growth costs

optimal sales force compensation we analyze a dynamic moral hazard model to derive optimal sales force compensation plans without imposing any ad hoc restrictions on the class of feasible incentive contracts we explain when the compensation plans that are most common in practice fixed salaries quota based bonuses commissions or a combination thereof are optimal fixed salaries are optimal for small revenue cost ratios quota based bonuses commissions should be used if the revenue cost ratio takes intermediate large values if firms face demand uncertainty markets are rather thin and the revenue cost ratio large firms should combine a commission with a quota based bonus if word of mouth advertising affects sales a dynamic commission that increases over time can be optimal when entering a new market or launching a new product firms should install long term bonus plans

moral hazard in repeated procurement of services this paper analyzes repeated procurement of services as a two period model with a potential repeated agency relationship in the first period there is an incumbent who provides a service in the second period there is a contest stage in which the principal selects the next service provider the agents effort is non contractible and the contest stage is the mechanism to mitigate potential moral hazard problems the principal takes account of the past service effort in the contest stage by choosing the weight of past effort and the degree of substitutability between past and current efforts the results show that when the principal does not value contest effort considering past effort as the relevant effort in the contest is optimal when the principal values contest effort and effort cost increases decreasing substitutability between efforts is optimal

how to design infrastructure contracts in a warming world a critical appraisal of public private partnerships we analyze how long term uncertainty for example regarding future climate conditions affects the design of concession contracts and organizational forms in a principal agent context with dynamic moral hazard limited liability and irreversibility constraints the prospect of future uncertain productivity shocks on the returns on the firm s effort creates an option value of delaying efforts a course that exacerbates agency costs contracts and organizational forms are drafted to control this cost of delegated flexibility the possibility for the agent to delay investment in response to uncertainty and irreversibility also elicits preference for unbundling different stages of the project through short term contracts our analysis is relevant to infrastructure sectors that are sensitive to changing weather conditions and sheds a pessimistic light on the relevance of public private partnerships in this context

moral hazard and capital structure dynamics we base a contracting theory for a start up firm on an agency model with observable but nonverifiable effort and renegotiable contracts two essential restrictions on simple contracts are imposed the entrepreneur must be given limited liability and the investor s earnings must not decrease in the realized profi to f thefirm all message game contracts with pure strategy equilibria and no third parties are considered within this class of contracts equilibria and regardless of who has the renegotiating bargaining power debt and convertible debt maximize the entrepreneur s incentives to exert effort these contracts are optimal if the entrepreneur has the bargaining power in renegotiation if the investor has the bargaining power the same is true unless debt induces excessive effort in the latter case a non debt simple contract achieves efficiency the non contractibility of effort does not lower welfare thus when the non contractibility of effort matters our results mirror typical capital structure dynamics an early use of debt claims followed by a switch to equity like claims

learning and incentive problems in repeated partnerships this paper analyzes optimal contracts for financing risky new projects in a two period agency model the principal and t he agent both learn about the project quality and the agent s unobservable actions affect the learning process the parties have access to the credit market compared to the short term contracts the long term contract induces the agent to work harder less hard in period one if his marginal effort in the first period increases reduces the value of information in both cases the long term contract enables the parties to learn more about the project type copyright 1993 by economics department of the university of pennsylvania and the osaka university institute of social and economic research association

arm s length relationships we show that lowering the cost of acquisition of information that a principal obtains about the performance of an agent may make it more difficult for the principal to commit to threats hence it will weaken incentives and can therefore be counterproductive this phenomenon is explored in a framework where improving the quality of information makes a commitment not to renegotiate less credible applications to the theory of the firm are briefly explored

downward nominal and real wage rigidity survey evidence from european firms it has been well established that the wages of individual workers react little especially downwards to shocks that hit their employer this paper presents new evidence from a unique survey of firms across europe on the prevalence of downward wage rigidity in both real and nominal terms the authors analyse which firm level and institutional factors are associated with wage rigidity the results indicate that it is related to workforce composition at the establishment level in a manner that is consistent with related theoretical models e g efficiency wage theory insider outsider theory the analysis also finds that wage rigidity depends on the labour market institutional environment collective bargaining coverage is positively related with downward real wage rigidity measured on the basis of wage indexation downward nominal wage rigidity is positively associated with the extent of permanent contracts and this effect is stronger in countries with stricter employment protection regulations

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

precautionary saving in the small and in the large the theory of precautionary saving is shown to be isomorphic to the arrow pratt theory of risk aversion making possible the application of a large body of knowledge about risk aversion to precautionary saving and more generally to the theory of optimal choice under risk in particular a measure of the strength of the precautionary saving motive analogous to the arrow pratt measure of risk aversion is used to establish a number of new propositions about precautionary saving and to give a new interpretation of the dreze modigliani substitution effect copyright 1990 by the econometric society

job design with conflicting tasks reconsidered a principal wants two sequential tasks to be performed by wealth constrained agents suppose that there is an outcome externality i e a first stage success can make second stage effort more or less effective if the tasks are conflicting the principal s profit maximizing way to induce high efforts is to hire one agent to perform both tasks so that the prospect to get a larger second stage rent after a first stage success motivates the agent to work hard in the first stage in contrast when there is an effort externality i e first stage effort reduces or increases the probability of a second stage success then the principal prefers to hire two agents whenever the tasks are conflicting

ex post unbalanced tournaments tournaments create strong incentives under the assumption that the competition between the agents is balanced if at the outset one agent is stronger than the other the tournament is ex ante unbalanced and incentives break down handicaps can in this case restore incentives in practice competing agents are often overall equally strong but have different sorts of strengths then competition will typically be unbalanced ex post and incentives break down but handicaps cannot be used we show how a simple means introducing the possibility of a tie can often resolve the problem we examine under what conditions incentives are maximized by ties

optimal incentives for teams much of the existing theory of incentives describes a static relationship that lasts for just one transaction this static assumption is not only unrealistic but the resulting predictions appear to be at odds with many work organizations the current paper introduces possible long term interaction among agents and studies how the design of explicit incentives and work organizations can exploit and interact with the implicit incentives generated by the repeated interaction of the agents the optimal incentive scheme is shown to display observed features of the increasingly popular teams such as the use of low powered group incentives