Knowledge that Transforms

We propose a theory of inefficient renegotiation that is based on loss aversion. When two parties write a long-term contract that has to be renegotiated after the realization of the state of the world, they take the initial contract as a reference point to which they compare gains and losses of the renegotiated transaction. We show that loss aversion makes the renegotiated outcome sticky and materially inefficient. The theory has important implications for the optimal design of long-term contracts. First, it explains why parties often abstain from writing a beneficial long-term contract or why some contracts specify transactions that are never ex post efficient. Secondly, it shows under what conditions parties should rely on the allocation of ownership rights to protect relationship-specific investments rather than writing a specific performance contract. Thirdly, it shows that employment contracts can be strictly optimal even if parties are free to renegotiate.

We conduct a series of laboratory experiments to understand what role commitment and reputation play in bargaining. The experiments implement the Abreu and Gul (2000) bargaining model that demonstrates how introducing behavioral types, which are obstinate in their demands, creates incentives for all players to build reputations for being hard bargainers. The data are qualitatively consistent with the theory, as subjects mimic induced types. Furthermore, we find evidence for the presence of complementary types, whose initial demands acquiesce to induced behavioural demands. However, there are quantitative deviations from the theory: subjects make aggressive demands too often and participate in longer conflicts before reaching agreements. Overall, the results suggest that the Abreu and Gul (2000) model can be used to gain insights to bargaining behavior, particularly in environments where the process underlying obstinate play is well established.

We develop a pure moral hazard model, and a closely related hybrid one, where there are both hidden actions and hidden information, to derive the restrictions from optimal contract theory that characterize set identification. In pure moral hazard models, the expected utility of managers is equalized across states, whereas in a hybrid model the optimal contract equates the expected utility of truth telling with the expected utility of lying. These restrictions are testable. Our identi…cation analysis establishes sharp and tight bounds on the identified set. Our tests and estimators are based on these bounds. We apply semiparametric methods to test the models, estimate the structural parameters, and quantify the effects of hidden actions versus hidden information. The pure moral hazard model is rejected on a large panel data set measuring the compensation of chief executive officers and the …financial and accounting returns of the publicly traded …firms they manage. We do not, however, reject the restrictions of the hybrid model, and our structural estimates for that model show the degree of private information varies considerably across sectors and over fi…rm size.

We introduce ex post participation constraints in the standard sequential screening model. This captures the presence of consumer withdrawal rights as, for instance, mandated by European Union regulation of “distance sales contracts”. With such additional constraints, the optimal contract is static and, unlike with only ex ante participation constraints, does not elicit the agent's information sequentially. This holds whenever differences in ex ante and ex post outside options are below a positive upper bound. Welfare effects of mandatory withdrawal rights are ambiguous. Since it is insufficient in our setting to consider only local incentive constraints, we develop a novel technique to identify the relevant global constraints.

We estimate the elasticity of exports to credit using matched customs and firm-level bank credit data from Peru. To account for non-credit determinants of exports, we compare changes in exports of the same product and to the same destination by firms borrowing from banks differentially affected by capital-flow reversals during the 2008 financial crisis. We find that credit shocks affect the intensive margin of exports, but have no significant impact on entry or exit of firms to new product and destination markets. Our results suggest that credit shortages reduce exports through raising the variable cost of production, rather than the cost of financing sunk entry investments.

We analyze a large, anonymous labour market in which firms motivate their workers via relational contracts. The market is frictionless and features on-the-job search, in that all acceptable vacancies are immediately filled and the employed compete with the unemployed for vacancies. While firms and workers are ex ante identical, the unique equilibrium exhibits a continuous distribution of contracts in which high wage firms have higher retention rates, more motivated workers and higher productivity. The model thus generates dispersion in wages, productivity and human resource strategies, and gives rise to endogenous job ladders. An exogenous increase in on-the-job search increases the quantity of jobs but decreases their quality; with sufficient on-the-job search there is full employment, and wage dispersion rather than unemployment motivates workers.

This article analyses costly information acquisition in asset markets with Knightian uncertainty about the asset fundamentals. In these markets, acquiring information not only reduces the expected variability of the fundamentals for a given distribution ( i.e . risk). It also mitigates the uncertainty about the true distribution of the fundamentals. Agents who lack knowledge of this distribution cannot correctly interpret the information other investors impound into the price. We show that, due to uncertainty aversion, the incentives to reduce uncertainty by acquiring information increase as more investors acquire information. When uncertainty is high enough, information acquisition decisions become strategic complements and lead to multiple equilibria. Swift changes in information demand can drive large price swings even after small changes in Knightian uncertainty.

In this article we examine the competitive equilibria of a dynamic stochastic economy with complete markets and collateral constraints. We show that, provided the sets of asset pay-offs and of collateral levels are sufficiently rich, the equilibrium allocations with sequential trades and collateral constraints are equivalent to those obtained in Arrow–Debreu markets subject to a series of limited pledgeability constraints. We provide both necessary and sufficient conditions for equilibria to be Pareto efficient and show that when collateral is scarce equilibria are not only Pareto inefficient but also often constrained inefficient, in the sense that imposing tighter borrowing restrictions can make everybody in the economy better off. We derive sufficient conditions for the existence of Markov equilibria and, for the case of two agents, for the existence of equilibria that have finite support. These equilibria can be computed with arbitrary accuracy and the model is very tractable.

For many goods and services such as electricity, health care, cellular phone service, debit-card transactions, or those sold with loyalty discounts, the price of the next unit of service depends on past usage. As a result, consumers who are inattentive to their past usage but are aware of contract terms may remain uncertain about the price of the next unit. I develop a model of inattentive consumption, derive equilibrium pricing when consumers are inattentive, and evaluate bill-shock regulation requiring firms to disclose information that substitutes for attention. When inattentive consumers are sophisticated but heterogeneous in their expected demand, bill-shock regulation reduces social welfare in fairly-competitive markets, which may be the effect of the Federal Communication Commission's recent bill-shock agreement. If some consumers are attentive while others naively fail to anticipate their own inattention, however, then bill-shock regulation increases social welfare and can benefit consumers. Hence, requiring zero-balance alerts in addition to the Federal Reserve's new opt-in rule for debit-card overdraft protection may benefit consumers.

Marriage institutions have changed over time, evolving from polygyny to monogamy, and then to serial monogamy (as defined by divorce and remarriage). We propose a unified theory of such institutional changes, where the dynamics of income distribution are the driving force. We characterize the marriage-market equilibrium in each of the three alternative regimes, and determine which one emerges as a political equilibrium, depending on the state of the economy. In a two-class society, a rise in the share of rich males drives the change from polygyny to monogamy. The introduction of serial monogamy follows from a further rise in the proportion of either rich females or rich males. Monogamy eases the transition to serial monogamy, since it promotes social mobility.