Browsing by Author "Taylor, Curtis R"

In this dissertation I study the role of limited commitment in dynamic models. In the first part, I consider firms that face uncertainty shocks in a principal-agent setting but have only limited ability to commit to long-term contracts. Limited commitment firms expedite payments to their managers when uncertainty is high, a finding that helps to explain the puzzling large bonuses observed during the recent financial crisis. In the second part, I examine a dynamic investment model where firms invest in a risky asset but cannot hedge the risk of their investment because they lack the ability to commit to future repayments of debt. Once firms have access to exogenous supply of risk free assets they may, on the aggregate level, invest more in the risky asset because risk free technology allows them to grow richer in equilibrium. This result helps to explain the asset price booms in emerging countries when those countries experience substantial capital outflow.

I characterize optimal long term contracts offered by a monopolist to a buyer whose private valuation evolves according to a branching process with privately known transition probability. The optimal contract can be implemented in a simple way, and presents the buyer with a tradeoff between a high initial fixed fee and low future prices. In an interaction with a long time horizon, the relationship will terminate prematurely with probability close to one. Optimal mechanisms are quite different from models in which the transition probability is known, and the buyer's private information is his initial valuation. Optimal contracts resemble the structure of term life insurance contracts, and have features similar to actual interactions between retailers and suppliers.

This dissertation consists of three main chapters - chapter 2, 3, and 4. These are different research problems studying the use of information. In chapter 2, we study a mechanism design problem where the Principal hires two agents to inspect a product, the quality of which is uncertain. The main research question we ask is the comparison of the inspection protocols. We found the optimality of sequential inspection among the protocols considered. We then extend the analysis to allow agents to differ and try to understand which is the better to order the agents when using the sequential protocol. In chapter 3, we study an information design problem where a present biased agent could commit to an information choice to help herself to save more that she would have. We provide a full characterization of the optimal information choice for a risk averse present biased agent. After that, as an effort to further understand the interaction between risk aversion and present bias, we introduce the EZKP framework and find a counterexample where risk aversion itself has no impact on the form of the information choice in a special case where the elasticity of the intertemporal substitution is fixed. In chapter 4, we study an information design in games problem where a designer chooses information for the agents to induce joint effort. We provide two examples illustrating the relative strength of two prominent constructions of the optimal information structure in the literature.

Chapter 2 considers income-share agreements (ISAs), which recently have been gaining traction as a way for students to finance college education, marketed as a way for students to reduce the down-side risk of winding up in a low-paying job with high student debt. Because ISA payments are a fraction of the on-the-job wage, incentives for both applicant and provider are different from a traditional debt-financed job applicant on the job market. I develop a labor-search model to show how financing affects job-market outcomes such as wages, search duration, and overall utility, set within an equilibrium framework in which the terms and methods of financing are endogenous. I show that ISAs can constitute an important part of the college-financing decision for financially-disadvantaged potential college students, and can act well as a substitute for traditional debt-markets when the cost of college is neither very low nor very high.

Chapter 3 considers a continuous-time organization design problem. Each member's output is an imperfect signal of his underlying effort, and each member's utility from remaining in the organization is endogenous to other members' efforts. Monetary transfers are assumed infeasible. Incentives can be provided only through two channels: expulsion following poor performance and respite following good performance. We derive the steady state distribution of members' continuation utilities for arbitrary values of the initial and maximum continuation utilities and then optimize these values according to organizational objectives. An optimally designed organization can be implemented by associating continuation utilities with a performance-tracking reputation system.

This thesis consists of three essays on dynamic contracts or games with incomplete information. In Chapter 1, I study concealing losses in dynamic relationships. I investigate a continuous-time reputation game, where an agent privately observes a Poisson process of losses and chooses whether to disclose them to the principal or to conceal them. By disclosing a loss, the agent passes on the consequences to the principal, which is an observable event. By concealing a loss, the agent bears the consequences himself, and the principal is unaware of the occurrence. The agent's type is private and uncertain: he is either strategic or honest. An honest agent faces a lower rate of losses and always discloses them. Both the principal and the agent enjoy a flow of benefits from the relationship while it is active. The principal, however, may unilaterally end the relationship at any time, and she prefers to maintain a relationship only with the low-frequency (honest) type. She learns about the agent's type through the pattern of disclosed losses. I characterize a class of equilibria with an intuitive structure consisting of a milking phase at high reputation and a building phase at low reputation. In the milking phase, every loss is passed through and is tolerated by the principal. In the building phase, the strategic type of agent probabilistically passes through losses and the principal randomly terminates the relationship when she incurs one. Applications include filing insurance claims, employees who make costly mistakes and friends or colleagues who ask for favors.

In Chapter 2, I employ novel methods to investigate optimal project management in a setting plagued by unavoidable setbacks. The contractor can cover up delays from shirking either by making false claims of setbacks or by postponing the reports of real ones. The sponsor induces work and honest reporting via a soft deadline and a reward for completion. Late-stage setbacks trigger randomization between cancellation and extension. Thus the project may run far beyond its initial schedule, generating arbitrarily large overruns, and yet be canceled. Absent commitment to randomize, the sponsor grants the contractor more time to complete the project.

In Chapter 3, I study the optimal incentive scheme for a long-term project with both moral hazard and adverse selection. The moral hazard issue is due to the fact that the agent's effort, which increases the arrival rate of a Poisson process, is not observable by the principal. In addition, the agent's effort cost, which needs to be reimbursed by the principal, is also the agent's private information. This gives rise to the adverse selection problem. The principal needs to design the optimal menu of contracts, each of which is chosen by the agent with a specific effort cost. I fully characterize the optimal menu in the case of two types of agents. Specifically, the agent with a lower cost is offered a probation contract, which confirms the agent's type if there is an arrival during a probation period; the agent with the higher cost is offered a sign-on-bonus contract with an immediate direct initial payment. I then explore the more general case with continuous types of agents. In particular, I provide an easy-to-compute upper bound on the principal's utility. The upper bound computation also yields a feasible menu of probation and sign-on-bonus contracts, and the corresponding lower bound it generates. I further provide a condition which can be used to verify whether the upper and lower bounds coincide, implying the optimality of our feasible menu of contracts. Numerical studies confirm that the verification condition almost always holds for commonly used probability distributions of the effort cost.

This dissertations consists of three essays on information and dynamic incentives.

In Chapter 1, I study the value of information in monotone decision problems where the action spaces are potentially multidimensional. As a criterion for comparing information structures, I develop a condition called monotone quasi-garbling meaning that an information structure is obtained by adding reversely monotone noise (more likely to return a higher signal in a lower state and a lower signal in a higher state) to another. It is shown that monotone quasi-garbling is a necessary and sufficient condition for decision makers to get a higher ex-ante expected payoff. Under the monotone likelihood ratio property, this new criterion is equivalent to the accuracy condition by Lehmann (1988) and refines the garbling condition by Blackwell (1951, 1953). To illustrate, I apply the result to problems in nonlinear monopoly pricing and optimal insurance.

In Chapter 2, I study a dynamic principal-agent problem where there are two routes of completing a project: directly attacking it or splitting it into two subprojects. When the project is split, the principal can better monitor the agent by verifying the completion of the first subproject. However, the inflexible nature of this approach may generate inefficiencies. To mitigate moral hazard, the principal needs to commit to a deadline, which also affects her choice of project management strategy. The optimal contract is determined by the interplay of these three factors: monitoring, efficiency, and an endogenous deadline.

Chapter 3, which is a joint work with Francisco Poggi, investigates firms' incentives to conceal intermediate research discoveries in innovation races. To study this, we introduce an innovation game where two racing firms dynamically allocate their resources between two distinct research and development (R&D) paths towards a final innovation: (i) developing it with the currently available but slower technology; (ii) conducting research to discover a faster new technology for developing it. We fully characterize the equilibrium behavior of the firms in the cases where their research progress is public and private information. Then, we extend the private information setting by allowing firms to conceal or license their intermediate discoveries. We show that when the reward of winning the race is high enough, firms would conceal their interim discoveries, which inefficiently retards the pace of innovation.

This dissertation uses game theoretic models to examine the effects of agent anonymity on markets for goods and for information. In open, anonymous settings, such as the Internet, anonymity is relatively easy to obtain --- oftentimes another email address is sufficient. By becoming anonymous, agents can participate in various mechanisms (such as elections, opinion polls, auctions, etc.) multiple times. The first chapter (joint work with Vincent Conitzer) studies elections that disincentivize voters from voting multiple times. A voting rule is false-name-proof if no agent ever benefits from casting additional votes. In elections with two alternatives, it is shown that there is a unique false-name-proof voting rule that is most responsive to votes. The probability that this rule selects the majority winner converges to 1 as the population grows large. Methods to design analogous rules for elections with 3 or more alternatives are proposed. The second chapter (also joint work with Vincent Conitzer) extends the analysis in the first chapter to broader mechanism design settings, where the goal is to disincentivize agents from participating multiple times. The cost model from the first chapter is generalized and revelation principles are proven. The third chapter studies a setting where firms are able to recognize their previous customers, and may use information about consumers' purchase histories to price discriminate (which may incentivize consumers to be anonymous). The formal model considers a monopolist and a continuum of heterogeneous consumers, where consumers are able to maintain their anonymity at some cost. It is shown that when consumers can costlessly maintain their anonymity, they all individually choose to do so, which paradoxically results in the highest profit for the monopolist. Increasing the cost of anonymity can benefit consumers, but only up to a point; at that point, the effect is reversed. Some of the results are extended to a setting with two competing firms selling differentiated products. Finally, the cost of maintaining anonymity is endogenized by considering a third party that can make consumers anonymous for a fee of its choosing. It is shown that this third party would prefer to be paid by the firm for allowing consumers to costlessly maintain their anonymity.

This dissertation collects work concerning the way individuals deal with imperfect information, both related to their knowledge of themselves and of others. The second chapter shows that bounded rationality, in the form of limited knowledge of utility, is an explanation for common stylized facts of prospect theory like loss aversion, status quo bias and non-linear probability weighting. Locally limited utility knowledge is considered within a classical demand model framework, suggesting that costs of inefficient search for optimal consumption will produce a value function that obeys the loss aversion axiom of Tversky and Kahneman (1991). Moreover, since this adjustment happens over time, new predictions are made that explain why the status quo bias is reinforced over time. This search can also describe the behavior of a consumer facing an uncertain future wealth level. The search cost justifies non-linear forms of probability weighting. The effects that have been observed in experiments will follow as a consequence.

The third chapter looks to understand how firms create and maintain long term relationships with consumers, or how procurement relations evolve over time, by studying a dynamic variant of the classical two-type-buyer contract in mechanism design. It is less trivial and more interesting if the utility determinant (or utility type) is not fixed or completely random, and fair assumptions are that it is either stochastic, or given by a distribution whose parameters are common knowledge. The first approach is that of Battaglini (2005), while the second is pursued in this paper. With two possible types of buyers, the buyer more likely to have a high utility type will receive the first-best allocations, while the other will receive the first best only if he has the high utility type.

The last chapter analyzes a dynamic procurement setting with promise keeping, where two firms (agents) with private information on their costs contract competitively with a principal. To this end, two models are proposed and the optimal allocations are determined. The agents face liquidity constraints, which induce distortions when high marginal costs are reported. We deduce that the principal uses promised utilities to incentivize the agents, which act as state variables in the recursive maximization problem. High cost types are allocated less than efficient quantities and the inefficiency of the allocation is relieved as the promised utilities increase.