Complete Contingent Contracts Research Articles

Dynamic Slot Allocations with Different Patience Levels

This study considers a mechanism design problem in which service slots are allocated over time to buyers arriving at different periods. Some buyers can accept delayed service, whereas others cannot. Buyers have a multidimensional type representing their valuation and patience level. The seller fully commits to a mechanism with or without complete contingent contracts. We show that a deterministic mechanism is periodic ex-post incentive compatible if and only if the allocation rule is monotone in valuation and the equivalence holds. In cases both with and without contingent contracts, the dynamic pivot mechanism with a reserve price maximizes the seller's expected revenue under a regularity condition, which is characterized by the linearity of the virtual valuation function. When the regularity holds, the fully optimal mechanism with contingent contracts is multi-contracting-proof, whereas the constrained optimal mechanism without contingent contracts is not.

Advice Is Cheap: Information Is Not!

An entrepreneur contracts with a consultant, who is protected by limited liability, to supply information about the state of a project prior to investing in it. For a given level of investment, a good project succeeds with higher probability than a bad one. The entrepreneur makes an upfront payment that the consultant can either invest in information acquisition (work) or divert for private benefit (shirk). If the consultant works, then he privately observes an unverifiable signal concerning the state of the project. Whether he works or shirks, the consultant reports a signal realization to the entrepreneur who then invests in the project in accordance with the advice she receives. Three contracting environments are considered: (i) complete contingent contracts in which compensation to the consultant may depend on reports, investment levels, and project outcomes; (ii) incomplete contingent contracts in which compensation may depend only on reports and project outcomes; and (iii) reputational contracts in which the consultant receives a non-contingent payment from a sequence of entrepreneurs so long as his referrals remain high. The principal under-utilizes information in settings (i) and (ii). In setting (iii) investments are statically but not dynamically efficient. For some parameter values the consultant shirks with positive probability and, therefore, supplies garbled advice. Finally, it is shown that if the consultant delivers no advice, then he nevertheless must be compensated in setting (i) and penalized in setting (iii).

Die Ausgestaltung von Versorgungsverträgen: Eine vertragstheoretische Analyse / A Contract Theory Approach to Health Care Contracting

Summary Transaction costs are an obstacle to the efficient operation of selective contracting. Health care delivery systems (§140 a-d SGB V) and selective contracting between networks of service providers and purchasers are advocated as an effective method to improve the performance of the German health care system. The problems of measurability, motivation associated with specific production of health care services forms a stronger regulatory environment. Contracting mechanisms should be analysed before purchasers can rely on obtaining these services from the selective contracting sector. This paper focuses on the theories from new institutional economics to analyze the policies of competitive contracting in the presence of asymmetric information, uncertainty and the inability to write complete contingent contracts. It is crucial, that both parties agree on the avoidance of endogenous risks and the procedures with unforeseeable contingencies (exogenous risks). Strategic behavior because of moral hazard and hold up situations is referred to endogenous risk. Uncertainty based on contingency, error and change of utilization are identified as exogenous risks. In order to control these risks structured renegotiations and risk-sharing and shared-saving arrangements should be scheduled.

Financial Intermediaries and Markets

A complex financial system comprises both financial markets and financial intermediaries. We distinguish financial intermediaries according to whether they issue complete contingent contracts or incomplete contracts. Intermediaries such as banks that issue incomplete contracts, e.g., demand deposits, are subject to runs, but this does not imply a market failure. A sophisticated financial system—a system with complete markets for aggregate risk and limited market participation—is incentive-efficient, if the intermediaries issue complete contingent contracts, or else constrained-efficient, if they issue incomplete contracts. We argue that there may be a role for regulating liquidity provision in an economy in which markets for aggregate risks are incomplete.

Corporate Governance in Germany: An Economic Perspective

A financial system can only perform its function of channelling funds from savers to investors if it offers sufficient assurance to the providers of the funds that they will reap the rewards which have been promised to them. To the extent that this assurance is not provided by contracts alone, potential financiers will want to monitor and influence managerial decisions. This is why corporate governance is an essential part of any financial system. It is almost obvious that providers of equity have a genuine interest in the functioning of corporate governance. However, corporate governance encompasses more than investor protection. Similar considerations also apply to other stakeholders who invest their resources in a firm and whose expectations of later receiving an appropriate return on their investment also depend on decisions at the level of the individual firm which would be extremely difficult to anticipate and prescribe in a set of complete contingent contracts. Lenders, especially long-term lenders, are one such group of stakeholders who may also want to play a role in corporate governance; employees, especially those with high skill levels and firm-specific knowledge, are another. The German corporate governance system is different from that of the Anglo-Saxon countries because it foresees the possibility, and even the necessity, to integrate lenders and employees in the governance of large corporations. The German corporate governance system is generally regarded as the standard example of an insider-controlled and stakeholder-oriented system. Moreover, only a few years ago it was a consistent system in the sense of being composed of complementary elements which fit together well. The first objective of this paper is to show why and in which respect these characterisations were once appropriate. However, the past decade has seen a wave of developments in the German corporate governance system, which make it worthwhile and indeed necessary to investigate whether German corporate governance has recently changed in a fundamental way. More specifically one can ask which elements and features of German corporate governance have in fact changed, why they have changed and whether those changes which did occur constitute a structural change which would have converted the old insider-controlled system into an outsider-controlled and shareholder-oriented system and/or would have deprived it of its former consistency. It is the second purpose of this paper to answer these questions.

Does Competition Solve the Hold-up Problem?

In an environment in which both buyers and sellers can undertake match specific investments, the presence of market competition for matches may solve hold-up and coordination problems generated by the absence of complete contingent contracts. In particular, this paper shows that when matching is assortative and sellers' investments precede market competition then investments are constrained efficient. One equilibrium is efficient with efficient matches but also there can be equilibria with coordination failures. Different types of efficiency arise when buyers undertake investment before market competition. These inefficiencies lead to buyers' under-investment due to a hold-up problem but, when competition is at its peak, there is a unique equilibrium of the competition game with efficient matches - no coordination failures - and the aggregate hold-up inefficiency is small in a well defined sense, independent of market size.

Competition and Hold-Ups

In an environment in which both workers and firms undertake match specific investments, the presence of market competition for matches may solve the hold-up problems generated by the absence of complete contingent contracts. In particular, this paper shows that in a world in which workers' and firms' investments are separated by market competition and contracts specify a simple (non-contingent) wage payment, investments are constrained efficient. Indeed, workers and firms invest efficiently given the equilibrium matches in which they are involved.

Contract renegotiation in a continuous state space

When players are unable to write complete state contingent contracts it is shown, within the context of a non-cooperative contracting-renegotiation game, that the only subgame perfect equilibrium allocations are those that correspond to the set of first-best allocations. Players are able to implement this set of allocations by signing an initial contract that is subsequently renegotiated in all states of the world. The contracting-renegotiation problem is complicated in an interesting way by assuming that the state space is continuous. The issue of the existence of an initial contract, that is subsequently renegotiated to the set of first-best allocations, must be resolved. Unlike Aghion, Dewatripont and Rey [1994], the results here do not require nor depend upon the comonotonicity of the objective functions.

Electricity rationing through a two-stage mechanism

Analysis of interruptible service mechanisms has focused on the efficiency losses due to the absence of complete contingent contracts. There exists a second type of inefficiency which, to a large extent, has been ignored. It originates from the fact that the relative order, or ranking, of consumers' willingness to pay for a given quantity generally varies throughout the contract period. A more general model of electricity demand allowing for changes in the order of consumer willingness to pay for a given quantity is presented. Under such demand conditions, the use of a two-stage rationing mechanism is proposed. Rationing plans which maximize expected aggregate surplus are established in the first stage. The second stage consists in a market for allocation rights to be operated once the states of nature are revealed. Allocations under this two-stage mechanism are shown to be Pareto-superior to existing rationing plans. Directions for future research are discussed.

A Two-Stage Mechanism to Improve Electricity Rationing

Electricity cannot be stored economically and must be generated on demand. Because electricity demand is subject to cyclical and random fluctuations, an equilibrium price would change constantly and spot pricing would generate substantial information and transactions costs. In the absence of spot prices, the utility must install enough capacity to meet peak demand with a given probability, and design a rationing plan for when the reserve margin proves inadequate. To avoid building new generation facilities, electric utilities have devised innovative rationing plans. These plans, referred to as load management programs, allow the utility to curtail loads of a pre-determined group of consumers. Interruptible/Curtailable (I/C) programs are among the most popular.' Much of the analysis of these mechanisms has focused on the efficiency losses due to the absence of complete contingent contracts. Because transaction costs prevent the implementation of contracts which fully represent the states of nature, there is inefficiency in allocation at the time of interruption. There exists a second type of inefficiency which has largely been ignored. A central hypothesis underlying all of these models is that the relative order, or ranking, of consumers' willingness to pay remains unchanged throughout the contract period. This is a fairly restrictive assumption. In much the same way that prohibitive transaction costs preclude the use of complete contingent contracts, these costs also make it necessary that I/C contracts have relatively long durations (say 3-5 years). Within a long contract period, it seems unrealistic to assume invariance in the ordering of consumers' willingness to pay. Thus it becomes impossible to achieve an efficient allocation, at the time of interruption, without some revelation by consumers of their willingness to pay at the time of interruption.

Optimal Nonlinear Pricing and Contingent Contracts

Rationing of output may be required to allocate resources when it is costly to operate a system of spot markets. In electric power markets, for example, interruptible service is the most frequently used form of capacity-sensitive allocation after time-of-use pricing. This paper examines the welfare properties and ease of implementation of alternative rationing rules and the pricing of contracts based on rationing rules. The model allows for both demand and supply shocks. The theoretical analysis is illustrated by application to curtailment rules and pricing in electric power markets. Rationing rules are a means of sharing risk and joint costs. Insurance provides a means of sharing the financial costs of random events. However, there are additional welfare gains to be obtained from pooling physical quantities of goods in the presence of random demand and supply, see Spulber (1985). By rationing goods, the common costs of production or productive capacity can be reduced while also reducing individual risk. This explains in part the extensive attention devoted to rationing of electric power. Electric power is subject to significant randomness in both supply and demand. Allocation mechanisms based on prices that adjust in real time, on complete contingent contracts, or on renegotiation of contracts in response to new information can involve prohibitive transaction costs. Avoidance of the need to ration would require inefficiently high capacity investment. Electric utilities must therefore employ rationing rules. These rules must be

Asymmetric Information, Bank Lending, and Implicit Contracts: A Stylized Model of Customer Relationships

ABSTRACTCustomer relationships arise between banks and firms because, in the process of lending, a bank learns more than others about its own customers. This information asymmetry allows lenders to capture some of the rents generated by their older customers; competition thus drives banks to lend to new firms at interest rates which initially generate expected losses. As a result, the allocation of capital is shifted toward lower quality and inexperienced firms. This inefficiency is eliminated if complete contingent contracts are written or, when this is costly, if banks can make nonbinding commitments that, in equilibrium, are backed by reputation.

Contract types in the property market

Because of the extreme complexity of housing capital, it is difficult to specify the level and quality of housing investment in a legally binding contract. This paper studies relative merits of various contract types when complete contingent contracts are impossible. Contract types considered in this paper are purchase contracts, rental contracts of land, and rental contracts of housing, where the degree of security of tenure is an important choice variable in rental contracts. We focus on two characteristics of the property market: durability of housing capital and the moral hazard problem in housing maintenance.