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

the kyoto protocol a review and perspectives international concern about climate change has led to the kyoto protocol negotiated in 1997 which contains legally binding emission targets for industrialized countries to be achieved during the commitment period 2008 2012 while proponents of the protocol celebrate it as a breakthrough in international climate policy opponents criticize that its approach namely setting targets and timetables for emission reductions is seriously flawed this paper provides a critical assessment of the protocols potential performance and discusses amendments to foster its effectiveness and efficiency it concludes that even without any effective emission reductions in the initial commitment period the ratification of kyoto is important for the further policy process of climate protection the kyoto protocol has established a flexible broad based international mechanism that provides a valuable starting point for shaping efficient climate policies in the future

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

optimal pricing policy in the presence of experience effects i introduction in this paper we analyze the problem of optimal intertemporal pricing for a monopolist when cur rent and past output affect future cost and or demand conditions through experience in production and or in consumption learning by doing the experience curve contagion habit formation bandwagon and snob effects are all examples of terminologies used to describe such situations we call these experience effects for convenience and explore profit maximizing pricing behavior when such effects exist in the traditional profit maximization model a firm chooses the price output combination so as to maximize short run i e current profits the familiar mc mr equality given that price is higher than average variable cost and a nonbind ing capacity constraint is a necessary condition for price takers as well as price makers this as sumes that the current pricing decision has no bearing on the future so that long run profit is maximized by a series of short run maximizing

multi period contracts between principal and agent with adverse selection abstract multi period contracts with adverse selection at the time of contracting are studied with risk neutrality and independent private information all inefficiency arises in the first period only with positive serial correlation inefficiency is more pervasive but declines over time

optimal employment contracts in a principal agent relationship abstract two unique characteristics of modern japanese labor management practice are the prevalence of lifetime employment and of biannual bonuses in contrast these practices are relatively infrequent in the united states many of the explanations offered so far attribute the difference to cultural and or institutional differences in the two countries in this paper we present a different point of view one that provides an economic rationale for various practices the model developed is based upon the framework of the principal agent relationship the principal employer offers to the agent employee a contract which specifies contract length wage rate and profit sharing schedule so as to maximize the expected value of a stream of future profits the agent in turn accepts this contract if and only if he can make himself better off in doing so if the appropriate level of effort can be specified and enforced by the principal there is no agency problem the resulting outcome is said to be first best on the other hand in many situations the principal is not able to enforce the effort level due to for example monitoring costs or lack of observability thus in the presence of this agency problem the appropriate level of effort is chosen for any given contract by the agent in such a way that his expected utility is maximized the optimal contracts in this framework are said to be second best the main focus in the paper is on the second best case we find that the optimal contracts depend upon various factors such as labor productivity disutility of effort risk aversion alternate market opportunity transaction cost demand conditions and discount rates by using numerical examples obtained by dynamic programming we illustrate that any form of employment policy can be optimal for the appropriate situations in addition we estimate the agency cost or the incentive gap between the first best and second best solutions

equilibrium evolution and learning abstract in their evolutionary theory of economic change nelson and winter 1982 developed a model based on winter 1971 in which agents have limited information processing capacities nelson s and winter s belief that the model would always generate a static selection equilibrium is shown to be incorrect despite that error simulation experiments based on their model yield a number of interesting implications about the effects of learning on evolutionary mechanisms when decision makers learn simulated competitive industries are much less volatile than when they do not moreover the most orthodox results are found when entry is difficult and there are large fixed costs of production perfect contestability implies extreme volatility

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

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

agency costs and innovation abstract stylized facts indicate that small firms are responsible for a disproportionate share of innovative research there are many possible explanations for this fact the paper seeks to understand this phenomenon as the outcome of an optimal assignment of tasks across individuals and organizations it is shown that incentive costs associated with a given task depend on the total portfolio of tasks that an individual or an organization undertakes mixing hard to measure activities innovation with easy to measure activities routine is particularly costly since it will either lead to misallocation of attention across tasks or to misallocation of risk larger firms are at a comparative disadvantage in conducting highly innovative research because of the costs associated with managing a heterogeneous set of tasks it is further argued that optimal organizational responses to coordination and control of routine tasks will lead to bureaucratization within the firm and to financial constraints imposed by capital markets both of which are hostile to innovation

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

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

asymmetric information incentives and intrafirm resource allocation this paper considers the question how should a firm allocate a resource among divisions when the productivity of the resource in each division is known only to the division manager obviously if the divisions as represented by their managers are indifferent among various allocations of the resource the headquarters can simply request the division managers to reveal their private information on productivity knowing that the managers have no incentive to lie the resource allocation problem can then be solved under complete or at least symmetric information this aspect is a flaw in much of the recent literature on this topic i e there is nothing in the models considered which makes divisions prefer one allocation over another thus although in some cases elaborate allocation schemes are proposed and analyzed they are really unnecessary in the model we develop a division can produce the same output with less managerial effort if it is allocated more resources and effort is costly to the manager we further assume that this effort is unobservable by the headquarters so that it cannot infer divisional productivity from data on divisional output and managerial effort given these assumptions we seek an optimal resource allocation process our results show that certain types of transfer pricing schemes are optimal in particular if there are no potentially binding capacity constraints on production of the resource then an optimal process is for each division to choose a transfer price from a schedule announced by the headquarters division managers receive a fixed compensation minus the cost of the resource allocated to them at the chosen transfer price resources are allocated on the basis of the chosen transfer prices if there is a potentially binding constraint on resource production a somewhat more complicated but similar scheme is required

practice prize winner dynamic marketing budget allocation across countries products and marketing activities previous research on marketing budget decisions has shown that profit improvement from better allocation across products or regions is much higher than from improving the overall budget however despite its high managerial relevance contributions by marketing scholars are rare in this paper we introduce an innovative and feasible solution to the dynamic marketing budget allocation problem for multiproduct multicountry firms specifically our decision support model allows determining near optimal marketing budgets at the country product marketing activity level in an excel supported environment each year the model accounts for marketing dynamics and a product s growth potential as well as for trade offs with respect to marketing effectiveness and profit contribution the model has been successfully implemented at bayer one the world s largest pharmaceutical and chemical firms the profit improvement potential is more than 50 and worth nearly 500 million in incremental discounted cash flows

the learning curve and pricing in the chemical processing industries data on 37 chemical products are used to test a number of hypotheses about the learning curve and industrial price behavior the results document a strong and consistent learning effect learning is found to be a function of cumulated industry output and cumulated investment rather than calendar time standard economies of scale appear significant but small in magnitude relative to the learning effect variations in the slope of the learning curve are linked to differences in r d expenditures and capital intensity market concentration is found to be a strong influence on price flexibility and the timing of learningrelated price changes

repeated auctions of incentive contracts investment and bidding parity with an application to takeovers this article considers a two period model of natural monopoly and second sourcing the incumbent supplier invests in the first period after observing the incumbent s first period performance the buyer may break out in the second period the investment may or may not be transferable to the second source and it may be monetary or take the form of human capital we determine whether the incumbent should be favored at the reprocurement stage and how the slope of his incentive scheme should evolve over time we find that the gains from second sourcing are not so large as one might hope finally we reinterpret the second source as a raider and the breakout as a takeover we discuss the desirability of defensive tactics and obtain a rich set of testable implications concerning the size of managerial stock options the extent of defensive tactics the firm s performance and the probability of a takeover

repeated principal agent relationships with lending and borrowing abstract it is shown optimal long term contracts are strictly better than a series of unrelated short term contracts for two reasons long term contracts allow risk to be spread over time and the agent s intertemporal choices provide information about the unobservable random variable

managerial incentives for short term results a comment in managerial incentives for short term results narayanan 4 examines the manager s incentive to make a suboptimal decision in particular an incentive to choose projects that yield short term profits even when the manager is compensated with a long term contract this incentive to act myopically at the expense of shareholders welfare is attributed to the manager s very concern for the long term impact of current actions that is the desire to enhance reputation earlier to boost wages although this type of myopic behavior is a cause for great concern and narayanan s approach is interesting the particular model he develops has a serious drawback we discuss briefly in this note how the shareholders can easily anticipate and prevent the manager from making a suboptimal decision by providing proper incentive contracts using the model by harris and holmstrom 1 as a benchmark narayanan sets up a multiperiod principal agent relationship in which the manager s ability is unknown and project choice is unobservable by the shareholders since the manager s ability is unknown compensation depends upon the observable output not being able to observe the project choice the shareholders update their prior on the manager s ability according to their conjecture of the manager s project choice the manager in turn chooses a project so as to maximize expected future wage which depends upon the shareholders perception of the manager s ability by choosing a quicker return project the manager may induce the shareholders to attribute the extra dollars to higher ability resulting in greater wages in the future thus we have a game theoretic situation the illustrated game in the paper deals with two alternative projects yielding a 2 x 2 bimatrix nonconstant sum game with payoffs determined by the strategies and cash flows from the project given this game structure narayanan is able to obtain a unique nash equilibrium where both players use dominant strategies the choices of strategies for both players depend upon the value of 5k the difference between the manager s expected total wage from projects a and b regardless of the shareholders strategy conjecture on the project choice if 4k is positive negative both players choose a b as their dominant strategy this equilibrium can be summarized by a usual 2 x 2 matrix as follows

collusive market structure under learning by doing and increasing returns learning by doing and increasing returns are often perceived to have similar implications for market structure and conduct we analyse this in the context of an infinite horizon price setting game learning is shown to not reduce the viability of market sharing collusion between a given number of firms whereas intra period increasing returns invariably does we subsequently develop a model where the number of active firms is determined endogenously under the assumption that the post entry game is collusive in this model learning has no effect on concentration while scale economies increase concentration

managerial incentives and capital management the paper shows how career concerns rather than effort aversion can induce a natural incongruity in risk preferences between managers and superiors a model based on learning about managerial talent is developed to study second best contractual remedies we show that the optimal wage contract is an option of the value of the manager s human capital for insurance reasons and that consequently rationing of capital is often required to counterbalance the manager s resulting incentive to overinvest rationing is strictly superior to price decentralization offering one reason for the prevalence of centralized capital budgeting procedures

capital rationing and organizational slack in capital budgeting this paper reconciles three stylized facts about capital budgeting in firms and shows that they are tied to the presence of asymmetric information among the several members of the firm each with his or her own objectives and decisions the facts of interest are 1 the existence of organizational slack 2 the rationing of resources within organizations 3 the stated cut off rate for accepting capital projects in firms is often greater than the market rate of interest organizational slack is defined as the excess of resources allocated over the minimum necessary to accomplish the tasks assigned resource rationing is defined as the under allocation of resources i e an increase in the amount allocated would generate revenues in excess of its costs rationing and slack are both manifestations of ex post inefficiencies an lp model is used to show that these inefficiencies can occur in ex ante efficient organizational designs when asymmetric information is present the optimal allocation policy involves a hurdle rate criterion in which the hurdle rate is strictly in excess of the cost of capital thus inducing rationing in some states of the world typically resources are optimally allocated such that slack exists in other states the optimal allocation policy trades off these two inefficiencies