scholarly journals Financing Experimentation

2014 ◽  
Vol 6 (1) ◽  
pp. 315-349 ◽  
Author(s):  
Mikhail Drugov ◽  
Rocco Macchiavello
Keyword(s):  
Opportunity To Learn ◽  
Optimal Contract ◽  
Ex Post ◽  
Must Experiment

Entrepreneurs must experiment to learn how good they are at a new activity. What happens when the experimentation is financed by a lender? Under common scenarios, i.e., when there is the opportunity to learn by “starting small” or when “noncompete” clauses cannot be enforced ex post, we show that financing experimentation can become harder precisely when it is more profitable, i.e., for lower values of the known arm and for more optimistic priors. Endogenous collateral requirements (like those frequently observed in microcredit schemes) are shown to be part of the optimal contract. (JEL D82, G21, G32, L25, L26)

Legal Environment and Contractual Choice

2021 ◽  
Vol 0 (0) ◽  
Author(s):  
Ho Cheung Cheng
Keyword(s):  
Optimal Contract ◽  
Legal Environment ◽  
Gains From Trade ◽  
Legal Systems ◽  
Ex Post ◽  
Ex Ante ◽  
Contractual Choice

Abstract This paper considers contractual choice under imperfect legal systems, in particular, contracts with different timing of payment. Ex-ante payment contracts are risky for the buyer, because the seller may shirk. Ex-post payment contracts are risky for the seller, as the buyer may default. Optimal contract is solved for any given legal environment. Exchanges with lower gains from trade tend to adopt ex-post payment contracts. The seller is a better proposer than the buyer in terms of the efficiency of the proposed contract. Surprisingly, offering ex-ante payment contracts is not strictly better for the seller under any legal environment. Moreover, mixed payment contracts are also analyzed and shown to never be optimal.

The revelation principle and mechanism design

2020 ◽  
pp. 661-719
Author(s):  
David M. Kreps
Keyword(s):  
Mechanism Design ◽  
Adverse Selection ◽  
Optimal Contract ◽  
Gains From Trade ◽  
Revelation Principle ◽  
Ex Post ◽  
The Government ◽  
Role Of The Government

This chapter evaluates a more general attack on optimal contract and mechanism design stressing cases of adverse selection, which makes use of the revelation principle. One should be clear about the uses to which the revelation principle is put. It can be thought of as a statement about how actually to implement contracts. But it may be better to use it with greater circumspection as a tool of analysis for finding the limits of what outcomes can be implemented, without reference to how best to implement a particular outcome. In some contexts of direct revelation, there will be situations ex post where the party in the role of the government knows that it can obtain further gains from trade from one or more of the parties who participated. Meanwhile, in many applications of the revelation principle, the party in the role of mechanism designer must be able to commit credibly to no subsequent (re)negotiation once it learns the types of the parties with which it is dealing.

The Welfare Implications of Health Capital Investment

2014 ◽  
Vol 04 (02) ◽  
pp. 1450007 ◽  
Author(s):  
Sara B. Holland
Keyword(s):  
Health Care ◽  
Health Insurance ◽  
Capital Investment ◽  
Investment Decision ◽  
Optimal Contract ◽  
Health Capital ◽  
Ex Post ◽  
Investment Level ◽  
Welfare Implications ◽  
Provide Health Insurance

I present a model of the health capital investment decision of a firm using a moral hazard framework. Health capital investment increases the probability that a worker is present and productive. The firm cannot verify a worker's health capital investment decision. When a firm invests in health capital, the investment is verifiable because the firm contracts with the insurer. I derive the optimal contract for when the worker and for when the firm invests in health capital. When the firm invests in health capital, the level of investment is higher and wages are less volatile. In my model, firms invest more than workers because of a production externality and because it is less costly to invest in health capital than to compensate the worker for bearing the risk of an uncertain labor realization. This result improves welfare, contrary to the benchmark that workers consume more health care than is efficient ex post when firms provide health insurance. Unlike the benchmark model of a worker and insurer, my model includes a profit maximizing firm, includes an endogenous probability of getting sick, and allows the insurer to set premiums by anticipating the health care investment level of the insured.

scholarly journals The Optimal Multistage Effort and Contract of VC’s Joint Investment

2015 ◽  
Vol 2015 ◽  
pp. 1-14
Author(s):  
Meng Wu
Keyword(s):  
Capital Investment ◽  
Stackelberg Game ◽  
Decision Making Process ◽  
Game Model ◽  
Venture Capitalists ◽  
Optimal Contract ◽  
Venture Capital Investment ◽  
Ex Post ◽  
Ex Ante

If the venture project has a great demand of investment, venture entrepreneurs will seek multiple venture capitalists to ensure necessary funding. This paper discusses the decision-making process in the case that multiple venture capitalists invest in a single project. From the beginning of the project till the withdrawal of the investment, the efforts of both parties are long term and dynamic. We consider the Stackelberg game model for venture capital investment in multiple periods. Given the optimal efforts by the entrepreneurs, our results clearly show that as time goes, in every single period entrepreneurs will expect their share of revenue paid to shrink. In other words, they expect a higher ex ante payment and a lower ex post payment. But, in contrast, venture capitalists are expecting exactly the opposite. With a further analysis, we also design an optimal contract in multiple periods. Last but not the least, several issues to be further investigated are proposed as well.

scholarly journals Contractual Incompleteness for External Risks

2010 ◽  
Vol 10 (1) ◽  
Author(s):  
Susheng Wang
Keyword(s):  
Incomplete Contracts ◽  
Optimal Contract ◽  
Incomplete Contract ◽  
Employment Contract ◽  
Control Option ◽  
Ex Post ◽  
Ex Ante ◽  
Contractual Incompleteness ◽  
Incentive Problems

In a model with internal and external risks together with incentive problems, this paper investigates the role of a risky environment on contractual incompleteness. We consider a typical employment contract with an extra control option. This option is contractable ex ante, exercisable ex post, and good for incentives. But, the employer may choose not to have it in a contract. We identify some interesting circumstances under which the option is not in the optimal contract. Our main findings are that (1) external risks determine contractual incompleteness, and (2) a complete contract can better handle incentives, while an incomplete contract can better handle external risks. Hence, our analysis of incomplete contracts is somewhat consistent with Williamson's (1985) idea of low-powered incentives inside the firm and high-powered incentives outside the firm.

Aid and terrorism: a dynamic contracts approach with interlinked moral hazard

2019 ◽  
Vol 13 (2) ◽  
pp. 415-448
Author(s):  
Jaideep Roy ◽  
Prabal Roy Chowdhury
Keyword(s):  
Moral Hazard ◽  
Poor Country ◽  
Dynamic Structure ◽  
Developing Nations ◽  
Development Aid ◽  
Policy Implications ◽  
Optimal Contract ◽  
Content Type ◽  
Ex Post ◽  
Altruistic Donor

Purpose In a global environment where terrorist organisations based in a poor country target a rich nation, this paper aims to study the properties of a dynamically incentive compatible contract designed by the target nation that involves joint counter-terror tasks with costly participation by each country. The counter-terror operations are however subject to ex post moral hazard, so that to incentivise counter-terror, the rich country supplies developmental aid. Development aid also helps avoid unrest arising from counter-terror activities in the target nation. However, aid itself can be diverted to non-developmental projects, generating a novel interlinked moral hazard problem spanning both tasks and rewards. Design/methodology/approach The authors use a dynamic model where the aid giving countries and aid receiving countries behave strategically. Then they solve for the sub game perfect Nash equilibrium of this game. Findings The authors characterise the optimal contract, showing that the dynamic structure of counter-terror resembles the shock-and-awe discussed by military strategists. The authors then prove that it is not necessarily the case that a more hawkish (resp. altruistic) donor is less pro-development (resp. softer on terror). In addition, the authors show that it may be easier to contract for higher counter-terror inputs when the recipient is more sympathetic to terrorists. The authors also discuss other problems faced by developing nations where this model can be readily adopted and the results can endorse appealing policy implications. Originality/value The authors characterise the optimal contract, showing that the dynamic structure of counter-terror resembles the shock-and-awe discussed by military strategists. It is proved that it is not necessarily the case that a more hawkish (resp. altruistic) donor is less pro-development (resp. softer on terror). In addition, the authors show that it may be easier to contract for higher counter-terror inputs when the recipient is more sympathetic to terrorists. Other problems faced by developing nations are also discussed where this model can be readily adopted, and the results can endorse appealing policy implications. These results have important policy implications, in particular in today’s world.

scholarly journals Optimal Contract under Moral Hazard with Soft Information

2013 ◽  
Vol 5 (4) ◽  
pp. 55-80 ◽  
Author(s):  
Guillaume Roger
Keyword(s):  
Moral Hazard ◽  
Adverse Selection ◽  
Soft Information ◽  
Optimal Contract ◽  
Strategic Complements ◽  
Ex Post ◽  
Ex Ante

I study a model of moral hazard with soft information: the agent alone observes the stochastic outcome of her action; hence the principal faces a problem of ex post adverse selection. With limited instruments the principal cannot solve these two problems independently; the ex post incentive for misreporting interacts with the ex ante incentives for effort. This affects the shape and properties of the optimal contract, which fails to elicit truthful revelation in all states. In this setup audit and transfer become strategic complements; this is rooted in the nonseparability of the problem. (JEL D82, D86)

scholarly journals Willpower and compromise effect

2020 ◽  
Vol 15 (1) ◽  
pp. 279-317 ◽  
Author(s):  
Yusufcan Masatlioglu ◽  
Daisuke Nakajima ◽  
Emre Ozdenoren
Keyword(s):  
Decision Making ◽  
Utility Maximization ◽  
Compromise Effect ◽  
Optimal Contract ◽  
Behavioral Traits ◽  
Cognitive Resource ◽  
Ex Post ◽  
Ex Ante ◽  
Profit Maximizing

This paper provides a behavioral foundation for modeling willpower as a limited cognitive resource that bridges the standard utility maximization and Strotz models. Using the agent's ex ante preferences and ex post choices, we derive a representation that captures key behavioral traits of willpower‐constrained decision making. We use the model to study the pricing problem of a profit‐maximizing monopolist who faces consumers with limited willpower. We show that the optimal contract often consists of three alternatives and that the consumer's choices reflect a form of the “compromise effect,” which is induced endogenously.

scholarly journals A Bargaining-Based Model of Security Design

2021 ◽  
Vol 13 (3) ◽  
pp. 443-473
Author(s):  
Matan Tsur
Keyword(s):  
Large Class ◽  
Bargaining Game ◽  
Optimal Contract ◽  
Security Design ◽  
Equilibrium Payoff ◽  
Multilateral Negotiations ◽  
Project Outcomes ◽  
Ex Post ◽  
Empirical Implications ◽  
A Share

This paper studies how security design affects project outcomes. Consider a firm that raises capital for multiple projects by offering investors a share of the revenues. The revenue of each project is determined ex post through bargaining with a buyer of the output. Thus, the choice of security affects the feasible payoffs of the bargaining game. We characterize the securities that achieve the firm’s maximal equilibrium payoff in bilateral and multilateral negotiations. In a large class of securities, the optimal contract is remarkably simple. The firm finances each project separately with defaultable debt. Welfare and empirical implications are discussed. (JEL C78, D21, D86, G12, G32)

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