Theoretical Economics, Volume 14, Number 3 (July 2019)

Theoretical Economics
Volume 14, Number 3 (July 2019)
Table of contents



Title: Efficient partnership formation in networks

Pages: 779-811

Authors: Francis Bloch, Bhaskar Dutta, Mihai Manea

Abstract: We analyze the formation of partnerships in social networks.
Players need favors at random times and ask their neighbors in the network to form exclusive long-term partnerships that guarantee reciprocal favor exchange. Refusing to provide a favor results in the automatic removal of the underlying link. Players agree to provide the first favor in a partnership only if they otherwise face the risk of eventual isolation. In equilibrium, players essential for realizing every maximum matching can avoid this risk and enjoy higher payoffs than inessential players. Although the search for partners is decentralized and reflects local partnership opportunities, the strength of essential players drives efficient partnership formation in every network. Equilibrium behavior is determined by the classification of nodes in the Gallai-Edmonds decomposition of the underlying network.

Keywords: Networks, efficiency, decentralized markets, partnerships, favor exchange, maximum matchings, Gallai-Edmonds decomposition, under-demanded

JEL classification: C78, D85


Title: Incentives, project choice, and dynamic multitasking

Pages: 813-847

Authors: Martin Szydlowski

Abstract: I study the optimal choice of projects in a continuous-time moral hazard model with multitasking. I characterize the distortions caused by moral hazard and the dynamics of the firm's project choice. Both overinvestment and underinvestment relative to an NPV criterion can occur on the path of the contract. As past performance increases, the firm chooses projects which require higher pay-performance sensitivity. When the continuation value is large, investment projects are chosen more efficiently, and project choice depends more on the NPV and less on the incentive costs. I implement the optimal contract with an equity stake, bonus payments, and a personal account.

Keywords: Continuous-time contracting, project choice, multitasking, bonus payments

JEL classification: D86, G11, G31, G32, M12, M52


Title: An N-person war of attrition with the possibility of a non-compromising type

Pages: 849-886

Authors: Shinsuke Kambe

Abstract: This paper studies an N-person war of attrition which needs one exit for its ending.  An N-person war of attrition is qualitatively different from its two-person version.  Only in the former, the set of players who are actively engaged in a war of attrition may change over time.  We introduce the possibility of a non-compromising type and characterize the unique equilibrium by identifying which players are actively involved in a war of attrition at each moment.  We examine who is likely to exit and when the war of attrition ends quickly.  As the leading example, we study how a group selects a volunteer in a dynamic setting.

Keywords: War of attrition, unique equilibrium

JEL classification: D71, C78


Title: Disputes, debt and equity

Pages: 887-925

Authors: Alfred J. M. Duncan, Charles Nolan

Abstract: We show how the prospect of disputes over firms' revenue reports promotes debt financing over equity. This is demonstrated in a costly state verification model with a risk averse entrepreneur. The prospect of disputes encourages incentive contracts that limit penalties and avoid stochastic monitoring, even when the lender can commit to stochastic monitoring. Consequently, optimal contracts shift from equity toward standard debt. In short: When audit signals are weakly correlated with true incomes, standard debt contracts emerge as optimal; if audit signals are highly correlated with true incomes, optimal contracts resemble equity. When audit costs are sufficiently high, stochastic monitoring may be optimal. Optimal standard debt contracts under imperfect audits are shown to reproduce key empirical facts of US firm borrowing.

Keywords: Microeconomics, costly state verification, external finance, leverage

JEL classification: D52, D53, D82, D86


Title: Competing mechanisms in markets for lemons

Pages: 927-970

Authors: Sarah Auster, Piero Gottardi

Abstract: We study directed search equilibria in a decentralized market with adverse selection, where uninformed buyers post general trading mechanisms and informed sellers select one of them. We show that this has differing and significant implications with respect to the traditional approach, based on bilateral contracting between the parties. In equilibrium, all buyers post the same mechanism and low-quality sellers receive priority in any meeting with a buyer. Also, buyers make strictly higher profits with low- than with high-type sellers. When adverse selection is severe, the equilibrium features rationing and is constrained inefficient. Compared to the equilibrium with bilateral contracting, the equilibrium with general mechanisms yields a higher surplus for most, but not all, parameter specifications.

Keywords: Competitive search, adverse selection

JEL classification: C78, D44, D83


Title: Renegotiation proof mechanism design with imperfect type verification

Pages: 971-1014

Authors: Francisco Silva

Abstract: I consider the interaction between an agent and a principal who is unable to commit not to renegotiate. The agent's type only affects the principal's utility. The principal has access to a public signal, correlated with the agent's type, which can be used to (imperfectly) verify the agent's report. I define renegotiation proof mechanisms and characterize the optimal one. The main finding of this paper is that the optimal renegotiation proof mechanism induces pooling at the top, i.e., types above a certain threshold report to be the largest type, while types below the threshold report truthfully.

Keywords: Renegotiation proof, mechanism design, verification

JEL classification: D8


Title: The loser's curse in the search for advice

Pages: 1015-1061

Authors: Pak Hung Au

Abstract: An agent searches sequentially for advice from multiple experts concerning the payoff of taking an operation. After incurring a positive search cost, the agent can consult an expert, whose interest is partially aligned with him. There are infinitely many experts, each has access to an identically and conditionally independent signal structure about the payoff, and each makes a recommendation after observing the signal realization. We find that the experts face a loser's curse, which could hamper the quality of information transmission. This effect is illustrated by studying the limit of equilibria with vanishing search cost. The main findings are as follows. First, there are signal structures with which both the agent's payoff and social welfare are strictly lower than the alternative scenario in which the agent commits to consulting a single expert only. Second, under some signal structures, no information can be transmitted in equilibrium, even though informative recommendation is possible if the agent could commit to a single expert. Finally, we identify the necessary and sufficient condition that ensures perfect information aggregation in the limit.

Keywords: Search, expert advice, information transmission, information aggregation

JEL classification: D83


Title: Optimal structure and dissolution of partnerships

Pages: 1063-1114

Authors: Simon Loertscher, Cédric Wasser

Abstract: For a partnership model with general type distributions and interdependent values, we derive the optimal dissolution mechanisms that, for arbitrary initial ownership, maximize any convex combination of revenue and social surplus. The solution involves ironing around typically interior worst-off types, which are endogenously determined. The optimal ownership structures are such that, with identical distributions, equal shares are always optimal. With non-identical distributions, the optimal shares are typically asymmetric; the identity of the agents with large shares may change with the importance of revenue generation; and even fully concentrated initial ownership, and assigning zero shares to the strongest agents, can be optimal.

Keywords: Partnership dissolution, mechanism design, property rights, interdependent values, asymmetric type distributions

JEL classification: D23, D61, D82


Title: Stochastic games with hidden states

Pages: 1115-1167

Authors: Yuichi Yamamoto

Abstract: This paper studies infinite-horizon stochastic games in which players observe payoffs and noisy public information about a hidden state each period. We find that, very generally, the feasible and individually rational payoff set is invariant to the initial prior about the state  in the limit as the discount factor goes to one. This result ensures that players can punish or reward the opponents via continuation payoffs in a flexible way. Then we prove the folk theorem, assuming that public randomization is available. The proof is constructive, and uses the idea of random blocks to design an effective punishment mechanism.

Keywords: Stochastic game, hidden state, uniform connectedness, robust connectedness, random blocks, folk theorem

JEL classification: C72, C73


Publication Date: 
Wednesday, August 21, 2019