Discussion Paper No. 120
November 5, 2021
Communicating Subjective Evaluations
Author:
Abstract:
Consider managers evaluating their employees' performances. Should managers justify their subjective evaluations? Suppose a manager's evaluation is private information. Justifying her evaluation is costly but limits the principal's scope for distorting her evaluation of the employee. I show that the manager justifies her evaluation if and only if the employee's performance was poor. The justification assures the employee that the manager has not distorted the evaluation downwards. For good performance, however, the manager pays a constant high wage without justification. The empirical literature demonstrates that subjective evaluations are lenient and discriminate poorly between good performance levels. This pattern was attributed to biased managers. I show that these effects occur in optimal contracts without any biased behavior.
Keywords:
communication; justification; subjective evaluation; centrality; leniency; disclosure;
JEL-Classification:
Download:
Discussion Paper No. 109
Consumer Exploitation and Notice Periods
Author:
Abstract:
Firms often set long notice periods when consumers cancel a contract, and sometimes do so even when the costs of changing or canceling the contract are small. We investigate a model in which a firm offers a contract to consumers who may procrastinate canceling it due to naive present-bias. We show that the firm may set a long notice period to exploit naive consumers.
Keywords:
notice periods; procrastination; present bias; time inconsistency; consumer naivete;
JEL-Classification:
Download:
Discussion Paper No. 103
Approximate Expected Utility Rationalization
Author:
Abstract:
We propose a new measure of deviations from expected utility, given data on economic choices under risk and uncertainty. In a revealed preference setup, and given a positive number e, we provide a characterization of the datasets whose deviation (in beliefs, utility, or perceived prices) is within e of expected utility theory. The number e can then be used as a distance to the theory. We apply our methodology to three recent large-scale experiments. Many subjects in those experiments are consistent with utility maximization, but not expected utility maximization. The correlation of our measure with demographics is also interesting, and provides new and intuitive findings on expected utility.
Keywords:
expected utility; revealed preference;
JEL-Classification:
Download:
Discussion Paper No. 57
November 4, 2021
The Impact of Social Media on Belief Formation
Author:
Abstract:
Social media are becoming increasingly important in our society and change the way people communicate, how they acquire information, and how they form beliefs. Experts are concerned that the rise of social media may make interaction and information exchange among like-minded individuals more pronounced and therefore lead to increased disagreement in a society. This paper analyzes a learning model with endogenous network formation in which people have different types and live in different regions. I show that when the importance of social media increases, the amount of disagreement in the society first decreases and then increases. Simultaneously people of the same type hold increasingly similar beliefs. Furthermore, people who find it hard to communicate with people in the same region may interact with similar people online and consequently hold extreme beliefs. Finally, I propose a simple way to model people who neglect a potential correlation of signals and show that these people may be made worse off by social media.
Keywords:
social media; network formation; social learning; polarization; homophily; correlation neglect;
JEL-Classification:
Download:
Discussion Paper No. 56
Optimal Cost Overruns: Procurement Auctions with Renegotiation
Author:
Abstract:
Cost overrun is ubiquitous in public procurement. We argue that this can be the result of a constrained optimal award procedure: The procurer awards the contract via a price-only auction and cannot commit not to renegotiate. If cost differences are more pronounced for a fancy than a standard design, it is optimal to fix the standard design ex ante. If renegotiation takes place and the fancy design has higher production costs or the contractor's bargaining position is strong, the final price exceeds the initial price. Moreover, the procurer cannot benefit from using a multi-dimensional auction, i.e., under the optimal scoring auction each supplier proposes the standard design.
Keywords:
auction; cost overrun; procurement; renegotiation;
JEL-Classification:
Download:
Discussion Paper No. 49
November 3, 2021
The Timing of Choice-Enhancing Policies
Author:
Abstract:
Recent studies investigate policies motivating consumers to make an active choice as a way to protect unsophisticated consumers. We analyze the optimal timing of such choice-enhancing policies when a firm can strategically react to them. In our model, a firm provides a contract with automatic renewal. We show that a policy intending to enhance consumers’ choices when they choose a contract can be detrimental to welfare. By contrast, a choice-enhancing policy at the time of contract renewal increases welfare more robustly. Our results highlight that policies should be targeted in timing to the actual choice inefficiency.
Keywords:
active choice; automatic renewal; automatic enrollment; procrastination; consumer naivete; present bias;
JEL-Classification:
Download:
Discussion Paper No. 47
Procurement with Unforeseen Contingencies
Author:
Abstract:
The procurement of complex projects is often plagued by large cost overruns. One important reason for these additional costs are flaws in the initial design. If the project is procured with a price-only auction, sellers who spotted some of the flaws have no incentive to reveal them early. Each seller prefers to conceal his information until he is awarded the contract and then renegotiate when he is in a bilateral monopoly position with the buyer. We show that this gives rise to three inefficiencies: inefficient renegotiation, inefficient production and ineffi- cient design. We derive the welfare optimal direct mechanism that implements the efficient allocation at the lowest possible cost to the buyer. The direct mechanism, however, imposes strong assumptions on the buyer’s prior knowledge of possible flaws and their payoff consequences. Therefore, we also propose an indirect me- chanism that implements the same allocation but does not require any such prior knowledge. The optimal direct and indirect mechanisms separate the improvement of the design and the selection of the seller who produces the good.
Keywords:
procurement; renegotiation; auctions; design flaws; adaption costs; behavioral contract theory;
JEL-Classification:
Download:
Discussion Paper No. 33
Motivated Health Risk Denial and Preventative Health Care Investments
Author:
Abstract:
People deny health risks, invest too little in disease prevention, and are highly sensitive to the price of preventative health care, especially in developing countries. Moreover, private sector R&D spending on developing-country diseases is almost non-existent. To explain these empirical observations, I propose a model of motivated belief formation, in which an agent’s decision to engage in health risk denial balances the psychological benefits of reduced anxiety with the physical cost of underprevention. I use the model to study firms’ price-setting behaviour and incentive to innovate. I also show that tax-funded prevention subsidies are welfare enhancing.
Keywords:
health risk denial; optimal expectations; motivated beliefs; disease prevention; self-protection;
JEL-Classification:
Download:
Discussion Paper No. 31
Competition and Incentives
Author:
Abstract:
We report on two experiments that identify non-monetary incentive effects of competition. As the number of competitors increases, monetary incentives to engage in cost reduction tend to decrease. We test the hypothesis that there are non-monetary incentive effects of competition going in the opposite direction. In the experiments we change the number of competitors exogenously keeping the monetary incentives to spend effort constant. The first experiment shows that subjects spend significantly more effort in duopolistic and oligopolistic markets than in a monopoly. The second experiment focuses on so- cial comparisons as one potential mechanism for this effect. It shows that competition turns the effort decisions of competing managers into strategic complements.
Keywords:
incentive effects of competition; behavioral industrial organization;
JEL-Classification:
Download:
Discussion Paper No. 19
The 2016 Nobel Memorial Prize in Contract Theory
Author:
Abstract:
Oliver Hart and Bengt Holmström were awarded the 2016 Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel for their fundamental contributions to contract theory. This article offers a short summary and discussion of their path breaking work.
Keywords:
contract theory; nobel prize; optimal incentive schemes; incomplete contracts;
JEL-Classification: