Principal-agent Framework Research Articles

Value Creation and Value Capture with Agency: the Micro-Foundations of Buyer-Supplier Relationships

We analyze the determinants of value creation and capture in a buyer-supplier relationship. In particular, we study how key contracting parameters, such as production efficiency, transactional integrity, incentive gaming and alignment affect outcomes when buyer faces competing suppliers. Bringing together the formalism of principal-agent framework with value-based analysis, we seek to understand the contracting micro-foundations behind choice of contracting partners and division of value. We show that transactional integrity and production efficiency are substitutes. We also find that distortion and resulting incentive gaming is unambiguously bad for welfare and hurts the buyer. For some suppliers however, value captured is maximized at intermediate levels of distortion. For alignment, we find that neither of the parties has incentives to sign a contract that maximizes value creation.

Manufacturer–retailer contracting with asymmetric information on retailer's degree of loss aversion

Abstract In a recent paper [Wang C., Webster S., 2007. Channel coordination for a supply chain with a risk-neutral manufacturer and a loss-averse retailer. Decision Sciences 38 (3), 361–389.], the authors study a supply chain consisting of a risk neutral manufacturer and a loss averse retailer and show that the supply chain can be coordinated by three contracts: buy back (BB), gain/loss sharing (GL) and gain/loss sharing and buy back (GLB). They assume that the retailer's degree of loss aversion is common knowledge. However, this assumption cannot reflect real situations, since in the real industry, one party's degree of loss aversion is usually unknown by other parties. In the present paper, we propose a principal-agent model, assuming the retailer's degree of loss aversion to be asymmetric information. Within the principal-agent framework, we obtain the following results: (1) An optimal MGL (modified GL) contract menu, which is based on the GL contract studied in Wang and Webster (2007) , is derived for the manufacturer (the principal) by mechanism design theory; (2) Under the MGL contract menu, information asymmetry lowers the production quantity, decreases the manufacturer's profit and deteriorates supply chain performance, while increasing the retailer's utility; (3) The MGL contract menu can coordinate the supply chain with asymmetric information in an implementable way if the wholesale price is endogenously determined by the manufacturer and its lower bound is 0.

Impatience vs. Incentives

This paper studies the long-run dynamics of Pareto-optimal self-enforcing contracts in a repeated principal-agent framework with dierential discounting. In such a setting, impatience concerns encourage contracts to favor the patient player in the long run and incentive concerns encourage contracts to favor the agent in the long run. When these two forces are aligned or one is relatively strong, we show that every Pareto-optimal self-enforcing contract converges to a steady state in the long run in a well-behaved way. In particular, the results of Ray (2002) and Lehrer and Pauzner (1999) can be recovered as limiting cases. However, when the forces are opposed and of comparable strength, our main result is that some Paretooptimal self-enforcing contracts deterministically oscillate between agent-preferred and principal-preferred states. Oscillation may be damped - so that in the long run a steady state is reached; or explosive until the allocation reaches one of the participation constraints and then alternates between a pair of states forever.

Value Creation and Value Capture with Agency: The Micro-Foundations of Buyer-Supplier Relationships

We analyze the determinants of value creation and capture in a buyer-supplier relationship. In particular, we study how key contracting parameters, such as production efficiency, transactional integrity, incentive gaming and alignment affect outcomes when buyer faces competing suppliers. Bringing together the formalism of principal-agent framework with value-based analysis, we seek to understand the contracting micro-foundations behind choice of contracting partners and division of value. We show that transactional integrity and production efficiency are substitutes. We also find that distortion and resulting incentive gaming is unambiguously bad for welfare and hurts the buyer. For some suppliers however, value captured is maximized at intermediate levels of distortion. For alignment, we find that neither of the parties has incentives to sign a contract that maximizes value creation.

Firm’s tax evasion in a principal-agent model with self-protection

Gatekeepers have an increasing role in taxation and regulation. Whereas burdening them with legal liability for misconducts that benefit those who resort to their services actually discourages wrongdoings—as will be clarified in the article—an alienation effect can also arise. The gatekeeper might become more interested in covering up the illegal behavior. This article studies the problem with respect to tax evasion by firms in a principal-agent framework. It highlights the role of legal rules pertaining to liability for tax evasion in shaping the choices of the parties, as concealment costs vary according to whether the risk-neutral principal or the riskaverse agent is held responsible when tax evasion is detected. The main result of the analysis is that there is a simple ex post test that can be carried out to infer whether harnessing the agent was socially beneficial.

Regulating Cross-border Higher Education: A Case Study of the United States

In an increasing number of nations, foreign education providers are becoming part of the educational landscape. This aspect of cross-border higher education raises many questions about how such activities are regulated, particularly the role of the importing and exporting governments. Drawing on a principal-agent framework, this study uses the United States, which is an amalgamation of more than 50 independent regulatory systems, to analyze how governments regulate the importing and exporting of public colleges and universities. The analysis reveals that state regulations primarily focus on issues pertaining to the approval process of expansion, mandating administrative requirements, providing comparable programs, and guarding against unnecessary competition; whereas there is limited focus on quality. Further, states have more extensive regulations for importing activities than exporting activities. These findings can help inform scholars and policymakers interested in multinational cross-border educational activities and the study serves as a prototype for other investigations of cross-border educational regulations.

Performance-Based Contracts for Outpatient Medical Services

In recent years, the performance-based approach to contracting for medical services has been gaining popularity across different healthcare delivery systems, both in the United States (under the name of “pay for performance”) and abroad (“payment by results” in the United Kingdom). The goal of our research is to build a unified performance-based contracting (PBC) framework that incorporates patient access-to-care requirements and that explicitly accounts for the complex outpatient care dynamics facilitated by the use of an online appointment scheduling system. We address the optimal contracting problem in a principal–agent framework where a service purchaser (the principal) minimizes her cost of purchasing the services and achieves the performance target (a waiting-time target) while taking into account the response of the provider (the agent) to the contract terms. Given the incentives offered by the contract, the provider maximizes his payoff by allocating his outpatient service capacity among three patient groups: urgent patients, dedicated advance patients, and flexible advance patients. We model the appointment dynamics as that of an M/D/1 queue and analyze several contracting approaches under adverse selection (asymmetric information) and moral hazard (private actions) settings. Our results show that simple and popular schemes used in practice cannot implement the first-best solution and that the linear performance-based contract cannot implement the second-best solution. To overcome these limitations, we propose a threshold-penalty PBC approach and show that it coordinates the system for an arbitrary patient mix and that it achieves the second-best performance for the setting where all advance patients are dedicated.

Understanding Maritime Piracy Syndicate Operations

In this article, I explain maritime piracy syndicates’ structure and behavior as based on two required inputs: the time needed between an attack and the realization of profit, and access to certain economic and security goods, namely a secure environment and market infrastructure. Pirates face two challenges. Internally, they must keep the organization together during the operation, a challenge I examine with a principal-agent framework to show how the inputs shape the security and control tradeoffs that exist, or not. Externally, pirates must maintain access to the external resources necessary for the success of their operation. I then turn to the adaptations in internal structure, targeting, and network connections that different types of pirate syndicates make to resolve principal-agent problems and external resource access problems during operations.

Dynamic contractual incentives in the face of a Samaritans’s dilemma

We design a project funding contract that provides optimal incentives to agents, in a setting where both principal and agent enjoy the benefits of the project in a non-rival form once completed but may differ in their valuation. To do so, we study optimal incentive payments in a dynamic principal-agent framework in which the principal cannot observe the agent’s investment, but only completed projects, and faces a Samaritan’s Dilemma: he cannot commit to terminate the contract before completion of the project. The agent decides whether to undertake a (discrete) investment or consume all received funds. We find that the optimal contract is stationary, and that either transfers equal to investment cost are incentive compatible or the cost of the contract is decreasing with the agent’s valuation of the projects. Given the intrinsic valuation of the project by the agent, he is always better off signing the contract in contraposition with the general moral hazard result.

Why Anticorruption Reforms Fail—Systemic Corruption as a Collective Action Problem

With an increased awareness of the detrimental effects of corruption on development, strategies to fight it are now a top priority in policy circles. Yet, in countries ridden with systemic corruption, few successes have resulted from the investment. On the basis of an interview study conducted in Kenya and Uganda—two arguably typically thoroughly corrupt countries—we argue that part of an explanation to why anticorruption reforms in countries plagued by widespread corruption fail is that they are based on a theoretical mischaracterization of the problem of systemic corruption. More specifically, the analysis reveals that while contemporary anticorruption reforms are based on a conceptualization of corruption as a principal–agent problem, in thoroughly corrupt settings, corruption rather resembles a collective action problem. This, in turn, leads to a breakdown of any anticorruption reform that builds on the principal–agent framework, taking the existence of noncorruptible so‐called principals for granted.

National Parliamentary Control of EU Affairs: Institutional Design after Enlargement

This article analyses the differences in institutional design in national parliamentary control over European Union affairs among EU member states. It proceeds from a preference-based perspective, drawing on the principal–agent framework, and a time-based perspective, inspired by the historical institutionalist approach. The article involves a qualitative comparative analysis of strong control and a quantitative, correlation analysis of variation in the degree of control. It argues that time-based factors provide a more persuasive overall explanation for the differences in control than preference-based factors.

Patient compliance, physician empathy and financial incentives within a principal-agent framework

Compliance with medication regimens among patients with chronic conditions in the U.S. and other developed countries averages only 50%. Numerous studies have attributed poor compliance to physicians’ failure to exhibit sufficient empathy with patients’ problems. Can financial incentives help modify physicians’ empathic behavior? In view of contradicting evidence in the health psychology literature, the present paper addresses this question from a rational-choice perspective, introducing a principal-agent model of physician empathy and patient compliance. The model allows the physician to exhibit empathy with the patient, to which the patient responds by choosing his desired level of compliance, which the physician takes into account when determining the level of empathy she exhibits. The model is first applied to rationally substantiate the evidence that patient compliance rises with physician empathy, and subsequently to examining the relationship between physician empathy and the physician's fee. The analysis reveals that the physician will exhibit less empathy in response to a higher fee, implying that the higher the fee the less compliant her patient will be.

Pricing Models for Online Advertising: CPM vs. CPC

Online advertising has transformed the advertising industry with its measurability and accountability. Online software and services supported by online advertising is becoming a reality as evidenced by the success of Google and its initiatives. Therefore, the choice of a pricing model for advertising becomes a critical issue for these firms. We present a formal model of pricing models in online advertising using the principal–agent framework to study the two most popular pricing models: input-based cost per thousand impressions (CPM) and performance-based cost per click-through (CPC). We identify four important factors that affect the preference of CPM to the CPC model, and vice versa. In particular, we highlight the interplay between uncertainty in the decision environment, value of advertising, cost of mistargeting advertisements, and alignment of incentives. These factors shed light on the preferred online-advertising pricing model for publishers and advertisers under different market conditions.

Responsive and Responsible Leaders: A Matter of Political Will?

Policy makers and policy-oriented scholars concerned with development and reform commonly appeal to “political will” as a cornerstone of development. We question the circular and voluntaristic view of leadership behavior inherent in such an approach, and argue that—to be more useful for the analysis of development outcomes, as well as for policy design—the discourse on political will should be firmly integrated into a more systematic framework of analysis. In particular, we suggest that it should engage in more active dialogue with the combined insights offered by principal-agent theory and what we refer to as state theory. More specifically, in the framework we develop, the principal-agent framework offers the analytical tools for analyzing leadership behavior at the micro level, while state theory provides crucial insights regarding the macro-level factors shaping leadership behavior. In the end, these two perspectives in tandem have the potential to significantly increase our understanding of empirically observed leadership behavior as well as our theoretical understanding of how the context—and especially the character of underlying social contracts—shapes and constrains “political will.”

On FTC's 'Do Not Track'

The Federal Trade Commission (FTC) has recently proposed a 'Do Not Track' mechanism in response to the fervent call for protecting consumer’s privacy online. We argue that restricting information collection is a misplaced focus in addressing Internet privacy, and develop a mechanism that helps alleviate consumer’s privacy concerns without sacrificing online firms’ business benefits from using customer information. Building on the proposed mechanism, we derive alternative regulatory tools that can be readily available to policy makers, and investigate their respective effectiveness in improving social welfare. We demonstrate that by leaving consumers partial control on how their information is used, the firm can devise a contract that serves the entire market while effectively catering to the privacy needs of different consumers. Further, results from our policy analysis suggest that imposing a requirement on preserving a portion of customer information purely for generating personalization is a superior strategy to restricting the firm’s ability to collect personal information. Our modeling approach offers an alternative to the reliance on external instruments in traditional contract design, and extends the principal-agent framework to a three-tier interaction in a non-price context. Further, our work is one of the first that respond to the FTC’s initiatives to pursue legislative options in protecting consumer’s online privacy, and offers important guidelines to regulators for governing the information practice of online companies.

The Turkish Military

One of the defining features of Turkish politics has been the strong influence of the military in civilian politics. However, since the early 2000s, we have seen unprecedented developments, substantially constraining the political powers of the military. How can we interpret this period from a historical perspective? What are the continuities and discontinuities in Turkish civil–military relations? Do these developments mark the end of military guardianship in the country? Employing the principal–agent framework, this study shows that the path of Turkish civil–military relations has been cyclical, where the status of the military has swung between agent and principal. Such swings have led to a significant degree of variance in the nature of the military guardianship. Thus, this study identifies two distinct stages of military tutelage during the Republican period: symbolic (1924–1960) and overt/ assertive (1960–2001). It is further argued that the recent reversion of the military back to agent of the civilian principals has initiated a post-guardianship era in Turkey.

All-or-nothing payments

We develop a general principal–agent framework in which to study optimal incentive schemes where agents are hired to work on multiple heterogeneous and interdependent projects. The incentive schemes can be based on output measures, interpreted as the principal’s payoffs, as well as input measures, regarded as observation of some of the agents’ efforts. We identify that a unifying feature of the optimal incentive schemes, called all-or-nothing payments, arises in three natural scenarios of the general framework: unobservable inputs, verifiable inputs, and observable but unverifiable inputs. Our framework and results embed and generalize several previous studies on multitask principal–agent problems with a limited liability constraint.

On Enterprise Operation Efficiency and Strategic Research Based on Super-efficient DEA

With the rapid development of China's electric power market today, the national provincial electric power companies, which are under the background of the principal-agent framework management, have become the main development pillars of the national electric power companies. These companies are responsible for many important businesses such as electric power market exploitation, power grid construction, electric power operation mode transformation, etc., and they are relatively independent management subject. How to evaluate the performance of provincial companies is always a focus point of the management of the national electric power company. The author tries to improve the C2R evaluation model of the DEA method and construct the super-efficient DEA evaluation model, in order to solve the problem that the sorting and selecting decision cannot be made when there are more than one effective decision unit, furthermore, to apply it to evaluate the operation efficiency of provincial companies and propose measures to improve business performance. The author hopes this can provide good ways of improving the reformation of electric power companies marketization in their reformation process.

Ponencias

We study a principal–agent framework in which principals can assign wage-irrelevant goals to agents. We find evidence that, when given the possibility to set wage-irrelevant goals, principals select incentive contracts for which pay is less responsive to agents' performance. Agents' performance is higher in the presence of goal setting despite weaker incentives. We develop a principal–agent model with reference-dependent utility that illustrates how labor contracts combining weak monetary incentives and wage-irrelevant goals can be optimal. The pervasive use of non-monetary incentives in the workplace may help account for previous empirical findings suggesting that firms rely on unexpectedly weak monetary incentives.

Fungibility and the Choice of Aid Modalities The Red Herring Revisited

The ‘right’ choice of instruments and modalities to provide aid to developing countries in support of poverty reduction and economic development is arguably the most contested issue in the current international debate on aid effectiveness. A particular controversy exists around the provision of aid in the form of budget support to avoid high transaction costs and other shortcomings of traditional project-based aid. Critics argue that this kind of ‘programme aid’ involves unacceptably high fiduciary risks due to the fungibility of budgetary funds. A more recently proposed form of aid is in the form of results-based aid or aid on delivery. Proponents argue that this provides donors with better control over the use of aid resources. This paper demonstrates in a simple principal-agent framework with asymmetric information that in the absence of transaction costs, for a wide range of combinations of aid dependency and recipient government commitment to reduce poverty, all three forms of aid are equivalent with regard to fungibility and fiduciary risks. The paper proceeds to demonstrate that as long as donors can rely on the recipient government to be at least minimally committed to poverty reduction, a well co-ordinated modality mix of general budget support and aid on delivery does not bear higher fiduciary risks than project aid. It concludes that if project aid does indeed involve higher transaction costs than budget support, donors should provide aid in the form of such a modality mix, albeit only if they are able (and willing) to closely co-ordinate their support.