14.129 Contract Theory, Spring 2003

T/Th 10-30 - 12:00



Bengt Holmstrom
E52-271d, 3-0506

Mathias Dewatripont
E52-391b, 8-9651

TA: Kenichi Amaya
E51-090, 8-5630

Reading List

^ = on reserve at Dewey Library
* = required reading; in JSTOR or on the Web
** = required reading; in reading packet

General References

Bolton, P. and M. Dewatripont (1998), Introduction to Contract Theory, book manuscript.

^Hart, O. (1995), Firms, Contracts and Financial Structure, Oxford, England: Oxford University Press.

^Laffont, J.-J. and J. Tirole (1993), A Theory of Incentives in Procurement and Regulation. Cambridge: MIT Press.

^Milgrom, P. and J. Roberts (1992). Economics, Organization and Management. Englewood Cliffs, N.J.: Prentice-Hall.

^Salanie, B. (1997), The Economics of Contracts: A Primer. MIT Press.

Williamson, O. (1985), The Economic Institutions of Capitalism, New York: Free Press.

1. Mechanism design and adverse selection (Holmstrom)

1.1 Static adverse selection

*Baron, D. and R. Myerson (1982), "Regulating a Monopolist with Unknown Costs," Econometrica, 50(4): 911-30.

**Bolton, P. and M. Dewatripont (2001), "Introduction to Contract Theory," book manuscript, chapter 2: Adverse selection: screening.

*Laffont, J-J and J. Tirole (1986), "Using Cost Observation to Regulate Firms," Journal of Political Economy, 94(3).

Laffont, J-J and J. Tirole (1993), A Theory of Procurement and Incentives in Regulation, Chapter 2.

*Maskin, E. and J. Riley (1984), "Monopoly with Incomplete Information," Rand Journal of Economics, 15: 171-96.

Mirrlees, J. (1971), "An exploration in the theory of optimum income taxation," Review of Economic Studies 38: 175-208.

Mussa, M. and S. Rosen (1978), "Monopoly and Product Quality," Journal of Economic Theory, 18: 301-317.

1.2 Mechanism design

**Bolton, P. and M. Dewatripont (2001), "Introduction to Contract Theory," book manuscript, chapter 8: Multiagent adverse selection.

Cremer, J. and R. McLean (1988), "Full Extraction of the Surplus in Bayesian and Dominant Strategy Auctions," Econometrica 56, 1247-1258.

**d'Aspremont, C. and L. Gerard-Varet (1979), "Incentives and Incomplete Information," Journal of Public Economics, 11: 24-45.

Holmstrom, B. and R. Myerson (1983), "Efficient and Durable Decision Rules with Incomplete Information," Econometrica, 51(6): 1799-1820.

**Myerson, Roger and M. Satterthwaite (1983) , "Efficient Mechanisms for Bilateral Trading," Journal of Economic Theory, 29: 265-281.

2. Dynamic agency (Holmstrom)

2.1 Dynamic moral hazard

Chiappori, P.A., I. Macho, P.Rey and B. Salanie (1994), "Repeated Moral Hazard: The Role of Memory, Commitment and the Access to Credit Markets," European Economic Review 38(8), 1527-53.

Clementi G. L. and H. Hopenhayn, (2002), "A Theory of Financing Constraints and Firm Dynamics," University of Rochester, Rochester Center for Economic Research, WP 492.

*Dewatripont, M., P. Legros and S. Mathews (2002), "Moral Hazard and Capital Structure Dynamics," mimeo, ECARES, Universite Libre de Bruxelles.

**Fudenberg, D., Holmstrom, B. and P. Milgrom (1990), "Short Term Contracts and Long Term Agency Relationships," Journal of Economic Theory, 51(1): 1-31.

Hellwig, M. and K. Schmidt (2002), "Discrete-time approximations of the Holmstrom-Milgrom Brownian-motion model of intertemporal incentive provision," Econometrica, 70 (6): 2225-64.

*Holmstrom, B. and P. Milgrom (1987), "Aggregation and Linearity in the Provision of Intertemporal Incentives," Econometrica, 55(2) p 303-328.

Malcomson , J. and F. Spinnewyn (1988), "The Multi-Period Principal-Agent Problem," Review of Economic Studies, 55(3): 391-407.

Radner, R. (1981), "Monitoring Cooperative Agreements in a Repeated Principal-Agent Relationship," Econometrica, 49(5): 1127-48.

Rogerson, W. (1985), "Repeated Moral Hazard," Econometrica, 53: 69-76.

*Spear, S. and S. Srivastava (1987), "On Repeated Moral Hazard with Discounting," Review of Economic Studies, 54: 599-617.

*Werning, I. (2001), "Repeated Moral Hazard with Unmonitored Wealth: A Recursive First-Order Approach," mimeo, University of Chicago.

2.2 Dynamic adverse selection

**Bolton, P. and M. Dewatripont (2001), "Introduction to Contract Theory," book manuscript, chapter 10: Dynamic Adverse Selection.

Dewatripont, M. (1989), "Renegotiation and Information Revelation over Time: The Case of Optimal Labor Contracts," Quarterly Journal of Economics, 104: 589-619.

**Dewatripont, M. and Maskin, E. (1990), "Contract Renegotiation in Models of Asymmetric Information," European Economic Review, 34(2-3): 311-321.

Fudenberg, D., and J. Tirole (1990). "Moral Hazard and Renegotiation in Agency Contracts," Econometrica 58(6): 1279-1319.

Hart, O. and J. Tirole (1988), "Contract Renegotiation and Coasian Dynamics," Review of Economic Studies, 55: 509-540.

2.3 Self-enforcing agreements and learning

*Abreu, D., D. Pearce and E. Stacchetti (1990), "Towards a Theory of Repeated Games with Discounting," Econometrica, 58 (5): 1041-1063.

Bergemann, D. and U. Hege (2000), "The Financing of Innovation: Learning and Stopping," mimeo, Yale University.

Diamond, D. (1989), "Reputation Acquisition in Debt Markets," Journal of Political Economy, 97(4), 828-62.

*Ely, J. and J. Valimaki (2001), "Bad Reputation," mimeo, Northwestern University.

Green, E. J. (1987), "Lending and Smoothing of Uninsurable Income" in Prescott, E. and Wallace, N. (eds), Contractual Arrangements for Intertemporal Trade , University of Minnesota Press.

Levin, J. (2002), "Relational Incentive Contracts," mimeo, Stanford University (also a link for an appendix).

Mailath, G. & L. Samuelson (2001), "Who Wants a Good Reputation?," Review of Economic Studies, 68(2), 415-41.

Ray, D. (2002), "The Time Structure of Self-Enforcing Agreements," Econometrica, 70 (2): 547-582.

*Tirole, J. (1996), "A Theory of Collective Reputations (with Applications to the Persistence of Corruption and to Firm Quality)," Review of Economic Studies, 63(1), 1-22.

*Townsend, R. (1982), "Optimal Multiperiod Contracts and the Gain from Enduring Relationships under Private Information," Journal of Political Economy, 90, 1166-86.

3. Politics: representation, accountability and bureaucracy (Holmstrom)

Acemoglu, D, M. Kremer and A. Mian (2002), "Markets, Firms, and Governments," mimeo, MIT.

*Aghion, P. and P. Bolton (2002), "Incomplete Social Contracts," mimeo, Princeton University.

Ashworth, Scott (1999), "Reputation Effects in Electoral Competition," mimeo, MIT.

Blanes-I-Vidal, J. (2001), "Authority and Career Concerns," mimeo, London School of Economics.

Banerjee, A. (1997), "A Theory of Misgovernance", Quarterly Journal of Economics, 112(4), 1289-1332.

*Caillaud B. and J. Tirole (2002), "Parties as Political Intermediaries," Quarterly Journal of Economics, 117(4): 1453-1490.

Dewatripont, M., I. Jewitt and J. Tirole (1999), "The Economics of Career Concerns, Part II: Application to Missions and Accountability of Government Agencies," The Review of Economic Studies, 66(1):199-217.

*Dewatripont, M. and J. Tirole (1999), "Advocates," Journal of Political Economy, 107(1): 1-39.

Hermalin, B. and M. Weisbach (1998), "Endogenously Chosen Boards of Directors and Their Monitoring of the CEO," American Economic Review, 88 (1): 96-118.

Lohmann, Susanne (1998), "An Information Rationale for the Power of Special Interests," The American Political Science Review, 92(4): 809-827.

*Maskin, E. and J. Tirole (2001), "The Politician and the Judge: Accountability in Government," mimeo, Princeton University.

*Milgrom P. and J. Roberts (1986), "Relying on the Information of Interested Parties," Rand Journal of Economics, 17(1): 18-32..

Persson T. and G. Tabellini (2000). Political Economics: Explaining Economic Policy, Cambridge and London: MIT Press.

Prendergast, C. (2001), "The Limits of Bureaucratic Efficiency," mimeo, Graduate School of Business, University of Chicago.

4. Internal vs. external capital markets (Holmstrom)

*Amador, M. and A. Landier (2002), "Entrepreneurial Pressure, Innovation and Rent Cannibalization," mimeo, MIT.

Berger, A., N. Miller, M. Petersen, R. Rajan, and J. Stein (2001), "Does Function Follow Organizational Form? Evidence from the Lending Practices of Large and Small Banks," mimeo, Harvard University.

*Gromb, D. and D. Scharfstein (2001), "Entrepreneurial Activity in Equilibrium," draft, Sloan School of Management.

Holmstrom, B. and S. Kaplan (2001), "Corporate Governance and Merger Activity in the United States: Making Sense of the 1980s and the 1990s," Journal of Economic Perspectives, 15 (2): 121-44.

*Inderst, R. and H. Mueller (2002), "Internal vs. External Financing: An Optimal Contracting Approach", working paper, University College London.

Stein, J.C. (1997), "Internal Capital Markets and the Competition for Corporate Resources," Journal of Finance, 52, 111-122.

* Stein, J.C. (2002), "Information Production and Capital Allocation: Decentralized vs. Hierarchical Firms," Journal of Finance, 57(5): 1891-1921.

5. Behavioral models of contracting (Holmstrom)

*Bernardo, A. and I. Welch (2001), "On the Evolution of Overconfidence and Entrepreneurs," Journal of Economics & Management Strategy, 10 (3): 301-330.

Englmaier, F. and A. Wambach (2002), "Contracts and Inequity Aversion," mimeo, University of Munich.

*Fehr, E. and K. Schmidt (1999), "A Theory of Fairness, Competition and Cooperation," Quarterly Journal of Economics, 114 (3): 817-868.

Gervais, S. and T. Odean (2001), "Learning to be Overconfident," Review of Financial Studies, 14 (1): 1-27.

*Rob, R. and P. Zemsky (2002), "Social Capital, Corporate Culture, and Incentive Intensity," Rand Journal of Economics, 33 (2), 243-257.

Van den Steen, E. (2002), "On the Origin and Evolution of Corporate Culture," mimeo, MIT.

6. Foundations of Incomplete Contracts (Dewatripont)

**^Bolton, P. and M. Dewatripont (2003), Contract Theory, book manuscript, Chapter 13: Foundations of contracting with unverifiable information

Aghion, P., M. Dewatripont and P. Rey (2002), "On Partial Contracting," European Economic Review, forthcoming.

Aghion, P., M. Dewatripont and P. Rey (2002), "Transferable Control," mimeo.

Dewatripont, M. (2001), "Authority," Walras-Bowley Lecture presented at the 2001 North-American Meeting of the Econometric Society.

* Hart, O. and J. Moore (1999), "Foundations of Incomplete contracts," Review of Economic Studies, 66(1): 115-38.

* Maskin, E. "Nash Equilibrium and Welfare Optimality," Review of Economic Studies, 66, 23-38 (1999).

Maskin, E. and J. Tirole (1999), "Unforeseen Contingencies and Incomplete Contracts," Review of Economic Studies.

Maskin, E. and J. Moore (1999), "Implementation and Renegotiation," Review of Economic Studies.

Moore, J. (1992), "Implementation in Environments with Complete Information," in Advances in Economic Theory: Sixth World Congress, J.J. Laffont, ed., Cambridge University Press, p.182-282.

Moore, J. and R. Repullo (1988) "Subgame Perfect Implementation," Econometrica, 56: 1191-1220.

* Segal, I. (1999), "Complexity and Renegotiation: A Foundation for Incomplete Contracts," Review of Economic Studies.

Segal, I. And M. Whinston (2002), "The Mirrlees Approach to Mechanism Design with Renegotiation (with Applications to Hold-up and Risk-Sharing)," Econometrica 70: 1-45.

**^ Tirole, J. (1999), "Incomplete Contracts: Where Do We Stand?" Econometrica, 67(4): 741-81

7. Internal Organization and Authority (Dewatripont)

7.1. Incentive approaches

* Aghion, P. and J. Tirole (1997), "Formal and Real Authority in Organizations," Journal of Political Economy, 105(1), 1-29.

Baron, D. and D. Besanko (1998), "Shared Incentive Authority and the Organization of the Firm," mimeo, Stanford.

**^ Dessein, W. (2002), "Authority and Communication in Organizations," Review of Economic Studies, 69, 811-38.

Dessein, W. (2002), "Information and Control in Alliances & Ventures", mimeo.

Dessein, W. (2002), "Coordination through Authority versus Consensus", mimeo.

Dewatripont, M. (2001), "Authority," Walras-Bowley Lecture presented at the 2001 North-American Meeting of the Econometric Society.

Garicano, L. and T. Santos (2001), "Referrals", mimeo.

**^ Hart, O. and B. Holmstrom (2002), "A Theory of Firm Scope," mimeo.

Levin J. and S. Tadelis (2001), "A Theory of Partnerships," draft, Stanford University.

Rajan, R. and L. Zingales (1998), "Power in a Theory of the Firm," Quarterly Journal of Economics, 113(2): 387-432.

Rey, P. and J. Tirole (2001), "Alignment of Interests and the Governance of Joint Ventures", mimeo.

Rotemberg, J. and G. Saloner (1994), "Benefits of Narrow Business Strategies," American Economic Review, 84(5), 1330-49.

Rotemberg, J. and G. Saloner (2000), "Visionaries, Managers and Strategic Direction," Rand Journal of Economics, 31(4), 693-716.

Van den Steen, E. (2001), "Organizational Beliefs and Managerial Vision," mimeo Sloan School of Management.

Segal, I. (1996), "Modeling the Managerial Task: A Synthetic Approach," mimeo, University of California, Berkeley.

Zabojnik, J. (2001), "Centralized and Decentralized Decision-Making in Organizations", Journal of Labor Economics, forthcoming.

7.2. Other approaches

* Bolton P. & M. Dewatripont (1994), "The Firm as a Communication Network", Quarterly Journal of Economics, 109: 809-839.

Bolton P. & M. Dewatripont (1995), "The Time and Budget Constraints of the Firm", European Economic Review.

**^ Dessein, W. And T. Santos (2002), "Adaptive organizations", mimeo.

Dewatripont, M. (2002), "Theories of Delegation: Communication Costs versus Incentive Approaches," Review of Economic Studies Lecture presented at the 2002 Royal Economic Society Conference, and Invited Presentation at the 2002 European Meeting of the Econometric Society.

Dewatripont M. & G. Roland (1997), "Transition as A Process of Large-Scale Institutional Change", in D. Kreps and K. Wallis (eds), Advances in Economic Theory, the Seventh World Congress, Cambridge, Cambridge University Press, vol. II, 240-278 (reprinted in Economics of Transition).

**^ Garicano L. (2000), "Hierarchies and the Organization of Knowledge in Production", Journal of Political Economy 108: 874-904.

**^ Hart, O. and J. Moore (2001), "On the design of hierarchies: coordination versus specialization," mimeo.

Meagher K., H. Orbay and T. Van Zandt (1999), "Firm Information Processing Structure and Environmental Uncertainty".

Qian Y., G. Roland & C. Xu (2000), "Coordinating Changes in M-Form and U-Form Organizations".

Radner R. (1992), "The Economics of Managing", Journal of Economic Literature.

* Radner R. (1992), "The Organization of Decentralized Information processing", Econometrica 62: 1109-46.

Van Zandt T. (1997), "Organisations with an Endogenous Number of Information Processing Agents", in M. Majumdar (ed), Organizations with Incomplete Information, Cambridge: Cambridge University Press.

Van Zandt T. (1999), "Real-Time Decentralized Information Processing as a Model of Organizations with Boundedly Rational Agents, Review of Economic Studies 66: 633-658.

Vayanos D. (1999), "Optimal Decentralization of Information Processing in the Presence of Synergies", mimeo, MIT.

8. Topics in adverse selection: multidimensional screening and competitive screening (Dewatripont)

Adams, W. and J. Yellen (1976), "Commodity bundling and the burden of monopoly," Quarterly Journal of Economics 90: 475-498.

Akerlof, G. (1970), "The Market for 'lemons': quality uncertainty and the market mechanism," Quarterly Journal of Economics, 84: 488-500.

Armstrong, M. (1996), "Multiproduct nonlinear pricing," Econometrica 64: 51-75.

Armstrong, M. (1999), "Price discrimination by a many-product firm," Review of Economic Studies 66: 151-168.

* Armstrong, M. and J. C. Rochet (1999), "Multidimensional Screening: a User's Guide," European Economic Review 43: 959-79.

Armstrong, M. and J. Vickers (2001), "Competitive price discrimination," Rand Journal of Economics 32: 579-605.

Biais, B., D. Martimort and J.C. Rochet (2000), "Competing Mechanisms in a Common Value Environment," Econometrica 68: 799-838.

**^ Bolton, P. and M. Dewatripont (2003), Contract Theory, book manuscript, chapter 6: Multidimensional incentive problems.

Dessein, W. (2002), "Network Competition in Nonlinear Pricing," Rand Journal of Economics forthcoming.

Jehiel, P., B. Moldovanu and E. Stacchetti (1999), "Multidimensional Mechanism Design for Auctions with Externalities", Journal of Economic Theory 85: 258-93.

Jullien, B. (2000), "Participation Constraints in Adverse Selection Models," Journal of Economic Theory 93: 1-47.

**^ Laffont, J.J., P. Rey and J. Tirole (1998), "Network Competition I and II," Rand Journal of Economics 29: 1-37 and 38-56.

Lewis, T. and D. Sappington (1989), "On Countervailing Incentives," Journal of Economic Theory 66: 238-63.

McAfee, R.P., J. McMillan and M. Whinston (1989), "Multiproduct monopoly, commodity bundling and the correlation of values," Quarterly Journal of Economics 103: 371-383.

Rochet, J.C. and P. Choné (1998), "Ironing, sweeping and multidimensional screening," Econometrica 66: 783-826.

Rochet, J.C. and L. Stole (1999), "Competitive Nonlinear Pricing," mimeo.

**^ Rochet, J.C. and L. Stole (2000), "The Economics of Multidimensional Screening," Econometric Society World Congress Invited Paper, Seattle 2000.

Rothschild, M. and J. Stiglitz (1976), "Equilibrium in competitive insurance markets: An essay in the economics of imperfect information," Quarterly Journal of Economics, 90: 629-649.

Wilson, R. (1993), Nonlinear Pricing, Oxford University Press.

9. Collusion, Cooperation and Hierarchies (Dewatripont)

**^ Bolton, P. and M. Dewatripont (2003), Contract Theory, book manuscript, chapter 8: Multiagent Moral Hazard and Collusion.

Calvo, G. and S. Wellisz (1978), "Supervision, Loss of Control, and the Optimum Size of the Firm," Journal of Political Economy 75: 123-38.

**^ Holmstrom, B. and P. Milgrom (1990), "Regulating Trade Among Agents," Journal of Institutional and Theoretical Economics, 146(1): 85-105.

Itoh, H. (1991), "Incentives to Help in Multi-Agent Situations," Econometrica, 59(3): 611-636.

Kofman, A. and J. Lawarrée (1993), "Collusion in Hierarchical Agency," Econometrica 61, 629-56.

*Laffont, J.-J. and D. Martimort (1997), "Collusion under Asymmetric Information," Econometrica, 65(4), 875-911.

**^ Laffont, J.-J. and D. Martimort (1998), "Mechanism Design with Collusion and Correlation," Econometrica, 68(2), 309-342.

Laffont, J.-J. and D. Martimort (1998), "Collusion and Delegation," Rand Journal of Economics, 29, 280-305.

McAfee, R. P. and J. McMillan (1995), "Organizational Diseconomies of Scale," Journal of Economics and Management Strategy 4: 399-426.

Qian, Y. (1994), "Incentives and Loss of Control in an Optimal Hierarchy", Review of Economic Studies 61: 527-44.

Maskin, E., Qian Y. & C. Xu (2000), "Incentives, Information and Organizational Form", Review of Economic Studies 67: 359-78.

Rotemberg, J. (1999), "Process- versus Function-Based Hierarchies," Journal of Economics and Management Strategy 8: 453-87.

Tirole, J. (1986), "Hierarchies and Bureaucracies: On the Role of Collusion in Organizations" Journal of Law, Economics and Organization, II(2):181-214.

**^ Tirole, J. (1992), "Collusion and the Theory of Organizations," in J.-J. Laffont (ed.), Advances in Economic Theory: Sixth World Congress, Volume 2, Econometric Society, Cambridge: Cambridge University Press, 151-206.