Knowledge that Transforms

The Grossman-Hart principal-agent model of moral hazard is extended to the multiple agent case to explore the use of relative performance in optimal incentive contracting. Under the assumption that the principal chooses incentive schemes to implement agent actions as Nash equilibria, necessary and sufficient conditions are derived for the optimality of independent contracts, of rank-order tournaments, and for attainability of the first-best. In this context the relation of the principal's welfare to the correlation between the underlying randomness in outputs of different agents is also investigated. Finally, some problems with the Nash equilibrium implementation assumption are discussed.

In this paper we study the role of promotional expenditures by sellers in a model of product differentiation. Advertising conveys full and accurate information about the characteristics of products. Heterogeneous consumers, who have no source of information other than advertisements, seek to purchase the products that best fit their needs. Despite the roles played by advertising in improving the matching of products and consumers, and in increasing the elasticity of demand faced by each firm, we find that the market-determined Jevels of advertising are excessive, given the extent of diversity in the market. We derive a promotional equilibrium based on a specific information transmission technology, paying explicit attention to the structure of consumer information and its impact on firms' demand curves. This allows us to study the effects of changes in the advertising technology, including an increased ability to target messages to specific groups of consumers, on the equilibrium in the product market. We find that decreased advertising costs may reduce profits by increasing the severity of price competition.

This paper is an analysis of when it will be beneficial for agents engaged in the production of information to form coalitions. The model is cast in a financial market framework, thus leading to an identification of conditions sufficient for the existence of financial intermediaries. Intermediation is shown to improve welfare if informational asymmetries are present, and the information generated to rectify these asymmetries is potentially unreliable. The usual appeal to transactions costs to explain intermediation is not needed.

This paper develops a theory of financial intermediation based on minimizing the cost of monitoring information which is useful for resolving incentive problems between borrowers and lenders. It presents a characterization of the costs of providing incentives for delegated monitoring by a financial intermediary. Diversification within an intermediary serves to reduce these costs, even in a risk neutral economy. The paper presents some more general analysis of the effect of diversification on resolving incentive problems. In the environment assumed in the model, debt contracts with costly bankruptcy are shown to be optimal. The analysis has implications for the portfolio structure and capital structure of intermediaries.

In a recent note in this Review, Arthur Hurter, Joseph Martinich, and Enrique Venta (hereafter Hurter et al.) consider the question of the conditions under which the location decision for a cost-minimizing firm can be treated separately from the decision governing the firm's desired input mix. The authors argue that if the firm's production function is homothetic, total costs can be minimized by first determining an optimal location for the facility, and then determining the optimal input mix at this location. The implication of this viewpoint is that facility location and facility design problems can be analyzed independently. Thus the traditional theory of the firms which abstracts from spatial elements, and the traditional Weberian theory of industrial location which does not consider the choice of input mix, remain independently valid without involving the possibility of suboptimal decision making on the part of the firm. My purpose here is to clarify the conditions under which this type of separability does obtain: in particular, I argue that the facility location problem can be solved independently of the input mix selection problem if and only if a firm's production function is of the fixed proportions type. This implies that homotheticity is neither necessary nor sufficient for separability of these decision problems.