Evidence on the incentive optimality of share contracts

Ever since Adam Smith, economists have argued that share contracts do not provide proper incentives. This paper uses tenancy data from India to assess the existence of missing incentives in this classical example of moral hazard. Sharecroppers are found to be less productive than owners, but as productive as fixed-rent tenants. Also, the productivity gap between owners and both types of tenants is driven by sample-selection issues. An endogenous selection rule matches tenancy contracts with less-skilled farmers and lower-quality lands. Due to complementarity, such a matching affects tenants’ input choices. Controlling for that, the contract form has no effect on the expected output. Next, I explicitly model farmer’s optimal decisions to test the existence of non-contractible inputs being misused. No evidence of missing incentives is found.

Capital Accumulation in the Presence of Informal Credit Contracts: Does the Incentive Mechanism Work Better than Credit Rationing Under Asymmetric Information?

Credit markets with asymmetric information often prefer credit rationing as a profit maximizing device. This paper asks whether the presence of informal credit markets reduces the cost of credit rationing, that is, whether it can alleviate the impact of asymmetric information based on the available information. We used a dynamic general equilibrium model with heterogenous agents to assess this. Using Indian credit market data our study shows that the presence of informal credit market can reduce the cost of credit rationing by separating high risk firms from the low risk firms in the informal market. But even after this improvement, the steady state capital accumulation is still much lower as compared to incentive based market clearing rates. Through self revelation of each firm's type, based on the incentive mechanism, banks can diversify their risk by achieving a separating equilibrium in the loan market. The incentive mechanism helps banks to increase capital accumulation in the long run by charging lower rates and lending relatively higher amount to the less risky firms. Another important finding of this study is that self-revelation leads to very significant welfare improvement, as measured by consumptiuon equivalence.

Temporary contracts and non-protected employment in Argentina, Chile and Perú: incidence and determinants

The diverse kinds of legal temporary contracts and the employment forms that do not comply with legal requirements both facilitate employment adjustment to firms´ requirements and entail labour cost reductions. Their employment incidence depends not only on the economic and labour market evolutions but also on other factors, in particular the historical trajectories followed by labour legislation, state enforcement, and the degree of compliance. To contribute to the understanding of the determinants of the degree of utilization of different employment practices, the study reported in this article explores the use made of the various legal temporary contracts and of precarious employment relationships by private enterprises in three Latin American countries (Argentina, Chile and Peru) during 2003-2012, a period of economic growth, and the explanatory role of diverse factors.

Choice of Contracts in the British National Health Service: An Empirical Study

Following major reforms of the British National Health Service (NHS) in 1990, the roles of purchasing and providing health services were separated, with the relationship between purchasers and providers governed by contracts. Using a mixed multinomial logit analysis, we show how this policy shift led to a selection of contracts that is consistent with the predictions of a simple model, based on contract theory, in which the characteristics of the health services being purchased and of the contracting parties influence the choice of contract form. The paper thus provides evidence in support of the practical relevance of theory in understanding health care market reform.

Optimal Contracts, Adverse Selection, and Social Preferences: An Experiment

It has long been standard in agency theory to search for incentive-compatible mechanisms on the assumption that people care only about their own material wealth. However, this assumption is clearly refuted by numerous experiments, and we feel that it may be useful to consider nonpecuniary utility in mechanism design and contract theory. Accordingly, we devise an experiment to explore optimal contracts in an adverse-selection context. A principal proposes one of three contract menus, each of which offers a choice of two incentive-compatible contracts, to two agents whose types are unknown to the principal. The agents know the set of possible menus, and choose to either accept one of the two contracts offered in the proposed menu or to reject the menu altogether; a rejection by either agent leads to lower (and equal) reservation payoffs for all parties. While all three possible menus favor the principal, they do so to varying degrees. We observe numerous rejections of the more lopsided menus, and approach an equilibrium where one of the more equitable contract menus (which one depends on the reservation payoffs) is proposed and agents accept a contract, selecting actions according to their types. Behavior is largely consistent with all recent models of social preferences, strongly suggesting there is value in considering nonpecuniary utility in agency theory.

Completing contracts ex post: How car manufacturers manage car dealers

This article illustrates how contracts are completed ex post in practice and, in so doing, indirectly suggests what the real function of contracts may be. Our evidence comes from the contracts between automobile manufacturers and their dealers in 23 dealership networks in Spain. Franchising dominates automobile distribution because of the need to decentralize pricing and control of service decisions. It motivates local managers to undertake these activities at minimum cost for the manufacturer. However, it creates incentive conflicts, both between manufacturers and dealers and among dealers themselves, concerning the level of sales and service provided. It also holds potential for expropriation of specific investments. Contracts deal with these conflicts by restricting dealers decision rights and granting manufacturers extensive completion, monitoring and enforcement powers. The main mechanism that may prevent abuse of these powers is the manufacturers reputational capital.

Recursive contracts

We obtain a recursive formulation for a general class of contractingproblems involving incentive constraints. Under these constraints,the corresponding maximization (sup) problems fails to have arecursive solution. Our approach consists of studying the Lagrangian.We show that, under standard assumptions, the solution to theLagrangian is characterized by a recursive saddle point (infsup)functional equation, analogous to Bellman's equation. Our approachapplies to a large class of contractual problems. As examples, westudy the optimal policy in a model with intertemporal participationconstraints (which arise in models of default) and intertemporalcompetitive constraints (which arise in Ramsey equilibria).

Optimal contracts, adverse selection and social preferences: An experiment

It has long been standard in agency theory to search for incentive-compatible mechanisms on the assumption that people care only about their own material wealth. However, this assumption is clearly refuted by numerous experiments, and we feel that it may be useful to consider nonpecuniary utility in mechanism design and contract theory. Accordingly, we devise an experiment to explore optimal contracts in an adverse-selection context. A principal proposes one of three contract menus, each of which offers a choice of two incentive-compatible contracts, to two agents whose types are unknown to the principal. The agents know the set of possible menus, and choose to either accept one of the two contracts offered in the proposed menu or to reject the menu altogether; a rejection by either agent leads to lower (and equal) reservation payoffs for all parties. While all three possible menus favor the principal, they do so to varying degrees. We observe numerous rejections of the more lopsided menus, and approach an equilibrium where one of the more equitable contract menus (which one depends on the reservation payoffs) is proposed and agents accept a contract, selecting actions according to their types. Behavior is largely consistent with all recent models of social preferences, strongly suggesting there is value in considering nonpecuniary utility in agency theory.

Moral hazard and non-exclusive contracts

This paper studies equilibria for economies characterized by moral hazard(hidden action), in which the set of contracts marketed in equilibrium isdetermined by the interaction of financial intermediaries.The crucial aspect of the environment that we study is thatintermediaries are restricted to trade non-exclusive contracts: theagents' contractual relationships with competing intermediaries cannot bemonitored (or are not contractible upon). We fully characterize equilibrium allocations and contracts. In thisset-up equilibrium allocations are clearly incentive constrainedinefficient. A robust property of equilibria with non-exclusivity isthat the contracts issued in equilibrium do not implement the optimalaction. Moreover we prove that, whenever equilibrium contracts doimplement the optimal action, intermediaries make positive profits andequilibrium allocations are third best inefficient (where the definitionof third best efficiency accounts for constraints which capture thenon-exclusivity of contracts).

The effects of tax deductibility on the mix of property taxes and use charges: an empirical analysis of the spanish case

This paper tests some hypothesis about the determinants of the local tax structure. In particular, we focus on the effects that the property tax deductibility in the national income tax has on the relative use of the property tax and user charges. We deal with the incentive effects that local governments face regarding the different sources of revenue by means of a model in which the local tax structure and the level of public expenditure arise as a result of the maximizing behaviour of local politicians subject to the economic effects of the tax system. We attempt to test the hypothesis developed with data corresponding to a set of Spanish municipalities during the period 1987-9l. We find that tax deductibility provides incentives to raise revenues from the property tax but does not introduce a biass against user charges or in favor of overall spending growth

The effects of tax deductibility on the mix of property taxes and use charges: an empirical analysis of the spanish case

This paper tests some hypothesis about the determinants of the local tax structure. In particular, we focus on the effects that the property tax deductibility in the national income tax has on the relative use of the property tax and user charges. We deal with the incentive effects that local governments face regarding the different sources of revenue by means of a model in which the local tax structure and the level of public expenditure arise as a result of the maximizing behaviour of local politicians subject to the economic effects of the tax system. We attempt to test the hypothesis developed with data corresponding to a set of Spanish municipalities during the period 1987-9l. We find that tax deductibility provides incentives to raise revenues from the property tax but does not introduce a biass against user charges or in favor of overall spending growth

Use of Incentive/Disincentive Contracting to Mitigate Work Zone Traffic Impacts, 2012

Incentive/disincentive clauses (I/D) are designed to award payments to contractors if they complete work ahead of schedule and to deduct payments if they exceed the completion time. A previously unanswered question is, “Did the costs of the actual work zone impacts that were avoided justify the incentives paid?” This report answers that question affirmatively based on an evaluation of 20 I/D projects in Missouri from 2008 to 2011. Road user costs (RUC) were used to quantify work zone impacts and included travel delays, vehicle operating costs, and crash costs. These were computed using work zone traffic conditions for partial-closure projects and detour volumes and routes for full-closure projects. Conditions during construction were compared to after construction. Crash costs were computed using Highway Safety Manual methodology. Safety Performance Functions produced annual crash frequencies that were translated into crash cost savings. In considering an average project, the percentage of RUC savings was around 13% of the total contract amount, or $444,389 of $3,464,620. The net RUC savings produced was around $7.2 million after subtracting the approximately $1.7 million paid in incentives. In other words, for every dollar paid in incentives, approximately 5.3 dollars of RUC savings resulted. I/D provisions were very successful in saving RUC for projects with full-closure, projects in urban areas, and emergency projects. Rural, non-emergency projects successfully saved RUC but not at the same level as other projects. The I/D contracts were also compared to all Missouri Department of Transportation contracts for the same time period. The results show that I/D projects had a higher on-time completion percentage and a higher number of bids per call than average projects. But I/D projects resulted in 4.52% higher deviation from programmed costs and possibly more changes made after the award. A survey of state transportation departments and contractors showed that both agreed to the same issues that affect the success of I/D contracts. Legal analysis suggests that liquidated damages is preferred to disincentives, since enforceability of disincentives may be an issue. Overall, in terms of work zone impact mitigation, I/D contracts are very effective at a relatively low cost.

Contracts and incentives in the construction sector

The aim of this chapter is to examine what the construction sector brings to our understanding of the procurement of complex performance. The chapter is divided into the following parts: fi rst, an overview of the various matters that contribute to the complexity of construction procurement is provided. Second, the most important contractual incentive schemes found in construction contracts are discussed, and this is followed by, third, an examination of the changes associated with the shift towards procuring complex performance (PCP) (service provision). Fourth, the main findings of the authors’ recent research on PCP contracts are summarised, followed by the conclusion. It should be noted that the procurement of services is referred to as ‘PCP’ in this chapter.