Browsing by Subject "Contracting"

I study the effect of human capital on firms' leverage decisions in a structural dynamic model. Firms produce using physical capital and labor. They pay a cost per employee they hire, thus investing in human capital. In default a portion of this human capital investment is lost. The loss of human capital constitutes a significant cost of financial distress. Labor intensive firms are more heavily exposed to this cost and respond by using less leverage. Thus the model predicts a decreasing relationship between leverage and labor intensity. Consistent with this prediction, I show in the data that high labor intensity leads to significantly less use of debt. In the model a move from the lowest to the highest decile of labor intensity is accompanied by a drop in leverage of 21 percentage points, very close to the 27 percentage point drop in the data. Overall, I argue that human capital has an important effect on firm leverage and should receive more attention from capital structure researchers.

Furthermore, I study a two-period contracting problem in which entrepreneurs need financing but have limited commitment. If an entrepreneur chooses to default, he can divert a proportion of the project's output. Entrepreneurs are heterogeneous with respect to their ability to divert output. In particular, I focus on the special case with only two types of entrepreneurs. "Opportunistic'' entrepreneurs can divert output, but "dependable'' entrepreneurs cannot. I find that, if the proportion of dependable entrepreneurs is sufficiently high, it is optimal to write contracts that induce second period default by the opportunistic entrepreneurs. This critical proportion generally decreases with the severity of the agency problem. The model delivers both cross-sectional and time-series predictions about default, investment, and output.

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.

This dissertation is comprised of three papers related to nonprofit market structure and its consequences. I begin with an essay that examines how the recent boom of nonprofit organizations affects giving using the context of the Combined Federal Campaign (CFC). I find that the nonprofit boom has not increased donations to nonprofit organizations. Since a fixed amount of charitable resources is split among more organizations, the average nonprofit receives less funding as the number of organizations grows. The second paper proposes a new definition of nonprofit markets based on individual-level donor behavior and donor-nonprofit network ties. Notably, the new market definition predicts donor substitution among organizations 58% more accurately than the standard nonprofit market definition based on an organization’s subsector and geographic location. The CFC data and this donor-based market definition are also used to examine an important nonprofit policy issue—the relationship between market concentration and nonprofit spending on overhead. In the final essay, I study one of the processes by which competition in the CFC has increased over time—changes in the structure of government contracts. I examine whether fewer, but larger, contracts change performance. I find that contract consolidation does not significantly improve performance. Furthermore, I find no evidence that economies of scale exist in workplace giving.