Endogenous Contracts Research Articles

Intensified distortion: Investment decisions with endogenous contracts and time inconsistency

Previous studies on investment decisions with endogenous contracts typically adopt differences among discount rates to describe decision makers’ impatience. Yet evidences from behavioral economics and neuroeconomics suggest that decision makers are impatient with short-term choices, but patient with long-term choices. Using quasi-hyperbolic discounting and real options agency framework, we investigate the effect of this time-vary impatience, i.e., time-inconsistent preference, on compensation contracts and investment triggers. We reveals that time inconsistency does not affect the dominance of restricted stock, but intensifies agency conflicts between the manager and shareholders. Our study provides a new perspective for understanding underinvestment and high equity incentives.

Overconfidence and Endogenous Contract Incompleteness

Overconfidence and Endogenous Contract Incompleteness

Coping with public-private partnership issues: A path forward to sustainable agriculture

Public-private partnerships are crucial for advancing agricultural sustainability and tackling issues related to enhancing global food security. They help make technology accessible to farmers so they can access markets. As PPPs bring together participants from the public, private, and civil society, they are commonly touted as a means of boosting productivity and fostering growth in the agriculture and food sectors. The PPP can assist in implementing cutting-edge technological breakthroughs and promoting private sector participation to reduce risks that could otherwise be excessive. PPPs are commonly understood as having the potential to modernize the agriculture industry and offer numerous concessions to help farmers achieve sustainable agricultural growth. The objective of the present study is to understand how these new partnerships are expected to play significant roles in identifying answers to the most important agricultural problems that Indian Agriculture is confronting. The study further aims to understand the critical issues in PPPs in the agriculture sector in the Indian context by analyzing their interrelationships and prioritization. The study utilizes Grey DEMATEL to determine these contextual relationships for PPP issues. Grey systems theory is a methodology that incorporates improbability and vagueness into the analysis. The critical issues in agricultural PPPs, as identified in the study, are “Complex and Time-Consuming Procedures”, “Governance Issues”, “Lack of Enabling Environment”, “Costly Contracting and Endogenous Contract Incompleteness”, and “Coordination Failures”. The present paper makes an effort to provide a detailed and exhaustive assessment of difficulties in agriculture PPPs in India, as well as a path forward for policymakers.

Overconfidence and Endogenous Contract Incompleteness

Overconfidence and Endogenous Contract Incompleteness

Estimating the relationship between collateral and interest rate: A comparison of methods

This paper uses a variety of estimation methods to explore the empirical relationship between interest rate and collateral requirements in bank loan contracts. Methods that do not allow for endogenous contract terms detect a positive reciprocal association between interest rate and collateral. Methods that allow for endogenous contract terms point to a strong positive effect of interest rate on collateral but the effect of collateral on interest rate is weaker. This highlights the importance of incorporating the endogenous nature of contract terms in empirical work.

Collective Moral Hazard and the Interbank Market

<ns2:p>The concentration of risk within financial system is considered to be a source of systemic instability. We propose a theory to explain the structure of the financial system and show how it alters the risk taking incentives of financial institutions. We build a model of portfolio choice and endogenous contracts in which the government optimally intervenes during crises. By issuing financial claims to other institutions, relatively risky institutions endogenously become large and interconnected. This structure enables institutions to share the risk of systemic crisis in a privately optimal way, but channels funds to relatively risky investments and creates incentives even for smaller institutions to take excessive risks. Constrained efficiency can be implemented with macroprudential regulation designed to limit the interconnectedness of risky institutions.</ns2:p>

Information Sharing and Rationing in Credit Markets

This article studies the effect of utilizing past credit information about borrowers on interest rates, collateral requirements, and credit rationing. Specifically, I develop a two‐period lending model with asymmetric information and endogenous contract terms, assuming a pooling equilibrium. I show that when default information is utilized privately, contract terms decrease under reasonable assumptions. When default information is also shared with other lenders, non‐defaulters enjoy better contract terms in period 2, while defaulters are offered worse terms, resulting in reduced adverse selection and more equitable terms on average for risk‐neutral borrowers. Finally, when borrowers are aware that information is utilized, information sharing also reduces moral hazard, collateral requirements, and credit rationing for all borrowers.

Contracting in Medical Equipment Maintenance Services: An Empirical Investigation

Maintenance service plans (MSPs) are contracts for the provision of maintenance by a service provider to an equipment operator. These plans can have different payment structures and risk allocations, which induce various types of incentives for agents in the service chain. How do such structures affect service performance and service chain value? We provide an empirical answer to this question by using unique panel data covering the sales and service records of more than 700 diagnostic body scanners. We exploit the presence of a standard warranty period and employ a matching approach to isolate the incentive effects of MSPs from the confounding effects of endogenous contract selection. We find that moving the equipment operator from a basic, pay-per-service plan to a fixed-fee, full-protection plan not only reduces reliability but also increases equipment service costs. Furthermore, that increase is driven by both the operator and the service provider. Our results indicate that incentive effects arising from MSPs leads to losses in service chain value, and we provide the first evidence that a basic pay-per-service plan—under which risk of equipment failure is borne by the operator—can improve performance and reduce costs. This paper was accepted by Gad Allon, operations management.

Vertical Arrangements and Upstream Mergers

We study the incentives for horizontal upstream mergers in a quantity-setting vertically related industry, under bargain and endogenous contract types. We show that the contract types used could have important consequences for the equilibrium market structure and vice versa. If it is the retailers who choose contract types, they share the same preferences as the policymakers and choose to offer two-part tariff contracts, leading the suppliers not to merge. This result has some obvious policy implications. If it is the suppliers who decide contract types, they prefer to merge and offer a partial forward vertical ownership scheme. Under Bertrand competition, there is always an upstream merger, but the common manufacturer will offer a two-part tariff contract for intermediate bargain power levels. For high bargain power levels, he will choose a partial forward vertical ownership scheme, while for low bargain power will suffer from negative profits. A policymaker, considering the maximization of the social welfare should consider the upstream merger and two-part tariff contracts.

Selection in Health Insurance Markets and Its Policy Remedies

In this essay, we review the theory and evidence concerning selection in competitive health insurance markets and discuss the common policy tools used to address the problems it creates. We begin by outlining some important but often misunderstood differences between two types of conceptual frameworks related to selection. The first, which we call the fixed contracts approach, takes insurance contract provisions as given and views selection as influencing only insurance prices in equilibrium. The second, the endogenous contracts approach, treats selection as also influencing the design of the contract itself, including the overall level of coverage and coverage for services that are differentially demanded by sicker consumers. After outlining the selection problems, we discuss four commonly employed policy instruments that affect the extent and impact of selection: 1) premium rating regulation, including community rating; 2) consumer subsidies or penalties to influence the take-up of insurance; 3) risk adjustment; and 4) contract regulation. We discuss these policies with reference to two markets that seem especially likely to be targets of reform in the short and medium term: Medicare Advantage and the individual insurance markets reformed by the Affordable Care Act of 2010.

Transcription upregulation via force-induced direct stretching of chromatin.

Mechanical forces play critical roles in the function of living cells. However, the underlying mechanisms of how forces influence nuclear events remain elusive. Here, we show that chromatin deformation as well as force-induced transcription of a green-fluorescent-protein (GFP) tagged bacterial-chromosome dihydrofolate reductase (DHFR) transgene can be visualized in a living cell by using three-dimensional magnetic twisting cytometry to apply local stresses on the cell surface via an Arg-Gly-Asp-coated magnetic bead. Chromatin stretching depended on loading direction. DHFR transcription upregulation was sensitive to load direction and proportional to the magnitude of chromatin stretching. Disrupting filamentous actin or inhibiting actomyosin contraction abrogated or attenuated force-induced DHFR transcription, whereas activating endogenous contraction upregulated force-induced DHFR transcription. Our findings suggest that local stresses applied to integrins propagate from the tensed actin cytoskeleton to the LINC complex and then through lamina-chromatin interactions to directly stretch chromatin and upregulate transcription.

Relative price variability and inflation: New evidence

This paper investigates the relationship between relative price variability (RPV) and inflation using monthly micro-price data for 128 goods in 13 Turkish regions/cities for the period 1994–2010. The unique feature of this data set is the inclusion of annual inflation rates ranging between 0% and 90%. Semi-parametric estimations show that there is a hump-shaped relationship between RPV and inflation, where the maximum RPV is achieved when annual inflation is approximately 20%. It is shown that this result is consistent with a region- or city-level homogenous menu cost model that features Calvo pricing with an endogenous contract structure and non-zero steady-state inflation.

The Effect of Endogenous Contract Selection on Budgetary Slack: An Experimental Examination of Trust, Distrust, and Trustworthiness

This study examines the effect of endogenous contract selection on budgetary slack using two slack-inducing contracts found in the literature: a trust contract where the superior must accept any feasible budget submitted by the subordinate and a discretion contract where the superior can accept or reject the budget. We find that both contracts generate less budgetary slack when they are endogenously selected by the superior than when they are randomly assigned by the experimenter. Exit questionnaire responses support our expectation that selecting a trust contract signals trust and expectations of trustworthiness whereas selecting a discretion contract signals distrust and an increased willingness to reject unreasonable budgets. We find the greatest level of efficiency with the endogenously selected discretion contract, which is not significantly different in efficiency than the optimal hurdle contract under traditional agency assumptions. Thus, our results suggest that endogenous contract selection improves efficiency whether it signals trust or distrust and signaling distrust may be optimal for the firm in some contracting settings.

INDIVIDUAL WELFARE WHEN CONSUMERS CAN SHOP FOR HEALTH INSURANCE

The statewide system of health insurance exchanges established by the Affordable Care Act (ACA) of 2010 will allow millions of U.S. citizens to change their health care policies more easily than they can switch automobile or homeowner insurance coverages, because deniability based on prior claim history is illegal. Focusing on this consumer endogeneity of health insurance policy choice, we examine the individual moral hazard welfare implications of a reduction in the price of medical care, which is a potential consequence of the ACA. We show that endogenous policy choice plays a key role in determining the welfare outcome. While moral hazard welfare improvement is not precluded, a distinctly possible outcome is that the consumer revises his/her choice of insurance policy so as to retain some portion of the reduction in expenditure risk caused by the medical care price decrease. In this event, moral hazard welfare loss is higher than it was before the price decrease, although the increased loss is tempered by the endogenous contract choice effect. This result resuscitates an old conventional wisdom. (JEL I11, I13, I30)

Failure to Launch: Housing, Debt Overhang, and the Inflation Option During the Great Recession

Can inflation cure mortgage debt overhang and mitigate the severity of housing busts? Focusing on the Great Recession, I address this question through the lens of a quantitative macroeconomic model of illiquid housing, endogenous mortgage pricing, and equilibrium default. First, I show that an increase in financial frictions accounts for half of the drop in real house prices, household net worth, and consumption during the Great Recession. However, a shock to housing liquidity is key to explaining the drop in housing sales, the increase in average time on the market, and the persistence of high foreclosure sales. A temporary surge of inflation leads to a moderate improvement in real house prices and inflation, though the endogenous contraction of mortgage credit partially offsets the direct debt erosion. However, a policy of nominal price level targeting that institutes high initial inflation followed by an extended disinflation leads to more promising results.

Vertical integration with endogenous contract leadership: Stability and fair profit allocation

This paper studies vertical integration in serial supply chains with a wholesale price contract. We consider a business environment where the contracting leader may be endogenously changed before and after forming the integration. A cooperative game is formulated to normatively analyze the stable and fair profit allocations under the grand coalition in such an environment. Our main result demonstrates that vertical integration is stable when all members are pessimistic in the sense that they are sure that they will not become the contracting leader if they deviate from the grand coalition. We find that in this case, the grand coalition’s profit must be allocated more to the retailer and the members with higher costs. Nevertheless, we also show the conditions under which the upstream manufacturer can have strong power as in traditional supply chains.

Effect of contextually congruent stallion vocalization playback on intrauterine pressure in the mare

Although oxytocin can be an effective treatment for persistent mating-induced endometritis (PMIE), frequent administration is required due to the short half-life of oxytocin and exogenous oxytocin may produce tetanic spasms of the myometrium. Teasing with a stallion during estrus elicits endogenous oxytocin secretion and uterine contractions, which may result in a more optimum physiologic response. Recently, it has been shown that mares will respond to contextually congruent stallion vocalization recordings with teasing behavior. The aim of this study was to determine if contextually congruent stallion vocalization would induce uterine contractions and increased uterine pressure in the mare. We hypothesized that teasing, contextually congruent stallion vocalization (with or without stallion scent), and exogenous oxytocin would increase intrauterine pressure in estrous pony mares, but that oxytocin would cause the greatest increases in intrauterine pressure. Changes in uterine pressure were recorded using a wireless telemetry capsule inserted into the uterine lumen (SmartPill pH.p Capsule), a novel method of instrumentation for uterine pressure studies. Twentyfour hours after administration of human chorionic gonadotropin, five reproductively normal pony mares were instrumented with an intrauterine telemetry pressure capsule during estrus. Baseline pressure was recorded for

Investment timing decisions of managers under endogenous contracts

This paper considers what kind of managerial compensation contract is optimal for mitigating the moral hazard decision regarding investment timing. We examine the situation where the personal objectives of managers do not align with those of shareholders and where there is the possibility of project liquidation but where managerial compensation is endogenously determined. Using a real options approach, we show that restricted stock is optimal relative to stock options under various circumstances. However, we also suggest that stock options are more likely to be used instead of, or in addition to, restricted stock in firms with new debt financing and more impatient managers, diversified firms involving more complicated business activities, and firms with weaker corporate governance. In addition, we find that project start-up is more likely to be deterred by the greater likelihood of project liquidation and larger managerial effort cost, whereas the amount of stock-based managerial compensation is independent of the probability of liquidation but is increasing in managerial effort cost.

Managers' Investment Timing Decisions under Endogenous Compensation Contracts

This paper considers how managers choose the timing of investment in risky but value-increasing projects with a liquidation possibility for their firm when their personal objectives are not aligned with those of shareholders but their compensation is endogenously determined. Using a real options approach for a broad class of managerial preferences, we show that without hidden information, the startup of the project is more likely to be delayed with a higher liquidation possibility, whereas the grant size of stock-based managerial compensation is independent of the liquidation possibility but is decreasing in the volatility of the firm's cash flow stream and the degree of managerial impatience if the manager is risk neutral. We also indicate that restricted stock is optimal in a general class of compensation schedules, regardless of the manager's risk preferences. Further, if there exists hidden information on the volatility of project returns and if the risk-neutral manager is as impatient as the shareholders, the equilibrium must be pooling. Then, the startup of the high- (low-)volatility project is advanced (delayed) in comparison with the case without hidden information.

Endogenous Preferences, Self-Control, and Dynamic Contract Design

People's past decisions often play a significant role in shaping their future preferences. Based on this premise, we propose a model of endogenously changing preferences in an intertemporal environment. The two types of agents are distinguished by their self-knowledge of the dynamically inconsistent preferences. In particular, we study the dynamic contract design problem of a monopolistic principal in this setup. Commitment contracts and spot contracts are contrasted. When types are known to the principal, commitment contracts are superior to spot arrangements. When types are unobservable, we arrive at several unconventional results. First, the first best outcome can still be achieved in the case of commitment contracts. Second, informational externality may extend in both directions when the first best spot contracts are not incentive compatible. Lastly, in the second best spot contracts, informational rent may accrue to both types of agents.