Our theory of costly contracts emphasizes the contractual rights can by of two types: specific rights and residual rights. When it is costly to list all specific rights over assets in the contract, it may be optimal to let one party purchase all residual rights. Ownership is the purchase of these residual rights. When residual rights are purchased by one party, they are lost by a second party, and this inevitably creates distortions. Firm 1 purchases firm 2 when firm 1's control increases the productivity of its management more than the loss of control decreases the productivity of firm 2's management.

/pdf/the-costs-and-benefits-of-ownership-a-theory-of-vertical-and-f6yl4obbds.pdf

The Costs and Benefits of Ownership: A Theory of Vertical and Lateral Integration

We analyze a sequential decision model in which each decision maker looks at the decisions made by previous decision makers in taking her own decision. This is rational for her because these other decision makers may have some information that is important for her. We then show that the decision rules that are chosen by optimizing individuals will be characterized by herd behavior; i.e., people will be doing what others are doing rather than using their information. We then show that the resulting equilibrium is inefficient.

/pdf/a-simple-model-of-herd-behavior-5cx0ldi3tv.pdf

A Simple Model of Herd Behavior

Introduction In the standard economic treatment of the principal–agent problem, compensation systems serve the dual function of allocating risks and rewarding productive work. A tension between these two functions arises when the agent is risk averse, for providing the agent with effective work incentives often forces him to bear unwanted risk. Existing formal models that have analyzed this tension, however, have produced only limited results. It remains a puzzle for this theory that employment contracts so often specify fixed wages and more generally that incentives within firms appear to be so muted, especially compared to those of the market. Also, the models have remained too intractable to effectively address broader organizational issues such as asset ownership, job design, and allocation of authority. In this article, we will analyze a principal–agent model that (i) can account for paying fixed wages even when good, objective output measures are available and agents are highly responsive to incentive pay; (ii) can make recommendations and predictions about ownership patterns even when contracts can take full account of all observable variables and court enforcement is perfect; (iii) can explain why employment is sometimes superior to independent contracting even when there are no productive advantages to specific physical or human capital and no financial market imperfections to limit the agent's borrowings; (iv) can explain bureaucratic constraints; and (v) can shed light on how tasks get allocated to different jobs.

/pdf/multitask-principal-agent-analyses-incentive-contracts-asset-1lc031chyk.pdf

Multitask Principal–Agent Analyses: Incentive Contracts, Asset Ownership, and Job Design

This paper explores the dynamics of allocation under increasing returns in a context where increasing returns arise naturally: agents choosing between technologies competing for adoption. Modern, complex technologies often display increasing returns to adoption in that the more they are adopted, the more experience is gained with them, and the more they are improved.1 When two or more increasing-return technologies 'compete' then, for a 'market' of potential adopters, insignificant events may by chance give one of them an initial advantage in adoptions. This technology may then improve more than the others, so it may appeal to a wider proportion of potential adopters. It may therefore become further adopted and further improved. Thus a technology that by chance gains an early lead in adoption may eventually 'corner the market' of potential adopters, with the other technologies becoming locked out. Of course, under different 'insignificant events' - unexpected successes in the performance of prototypes, whims of early developers, political circumstances - a different technology might achieve sufficient adoption and improvement to come to dominate. Competitions between technologies may have, multiple potential outcomes. It is well known that allocation problems with increasing returns tend to exhibit multiple equilibria, and so it is not surprising that multiple outcomes should appear here. Static analysis can typically locate these multiple equilibria, but usually it cannot tell us which one will be 'selected'. A dynamic approach might be able to say more. By allowing the possibility of 'random events' occurring during adoption, it might examine how these influence ' selection' of the outcome - how some sets of random 'historical events' might cumulate to drive the process towards one market-share outcome, others to drive it towards another. It might also reveal how the two familiar increasingreturns properties of non-predictability and potential inefficiency come about: how increasing returns act to magnify chance events as adoptions take place, so that

/pdf/competing-technologies-increasing-returns-and-lock-in-by-3xfy5hl1w5.pdf

Competing technologies, increasing returns, and lock-in by historical events*

An informational cascade occurs when it is optimal for an individual, having observed the actions of those ahead of him, to follow the behavior of the preceding individual without regard to his own information. We argue that localized conformity of behavior and the fragility of mass behaviors can be explained by informational cascades.

https://papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID1405027_code2024.pdf?abstractid=1286306&mirid=1&type=2

A Theory of Fads, Fashion, Custom, and Cultural Change as Informational Cascades

There are often benefits to consumers and to firms from standardization of a product. We examine whether these standardization benefits can "trap" an industry in an obsolete or inferior standard when there is a better alternative available. With complete information and identical preferences among firms the answer is no; but when information is incomplete this "excess inertia" can occur. We also discuss the extent to which the problem can be overcome by communication.

/pdf/standardization-compatibility-and-innovation-1e0gxf7gid.pdf

Standardization, compatibility, and innovation

A good is often more valuable to any user, the more others use compatible goods. The authors show that this effect may inhibit innovation. If an installed base exists and transition to a new standard must be gradual, early adopters bear a disproportionate share of transient incompatibility costs. This can produce "excess inertia." The installed base, however, is "stranded" if the new standard is adopted: this may create "excess momentum." These dynamic effects have strategic implications. Temporary price cutting can permanently prevent entry; and product preannouncements can be critical in innovation. These strategic actions have ambiguous welfare effects.

Installed base and compatibility : innovation, product preannouncements and predation

The authors analyze horizontal mergers in Cournot oligopoly. They find general conditions under which such mergers raise price, and show that any merger not creating synergies raises price. The authors develop a procedure for analyzing the effect of a merger on rivals and consumers and, thus, provide sufficient conditions for profitable mergers to raise welfare. They show that traditional merger analysis can be misleading in its use of the Herfindahl Index. Their analysis stresses the output responses of large firms not participating in the merger. Copyright 1990 by American Economic Association.(This abstract was borrowed from another version of this item.)

Horizontal Mergers: An Equilibrium Analysis

UNIVERSITY OF CALIFORNIA, BERKELEY Department o f Economics Berkeley, C a l i f o r n i a Working Paper 8880 HORIZONTAL MERGERS: AN EQUILIBRIUM ANALYSIS Joseph F a r r e l l and C a r l Shapiro U.C. B e r k e l e y and P r i n c e t o n U n i v e r s i t y June 16, 1988 Key words: mergers, oligopoly. Abstract We a n a l y z e mergers as c o n c e n t r a t i o n - i n c r e a s i n g t r a n s f e r s o f industry-specific c a p i t a l among o l i g o p o l i s t s . Such c a p i t a l t r a n s f e r s a f f e c t i n d u s t r y s t r u c t u r e , and induce changes i n t h e subsequent o l i g o p o l i s t i c Cournot e q u i l i b r i u m . We p r o v i d e g e n e r a l c o n d i t i o n s under which they r a i s e t h e market p r i c e . We a l s o examine t h e s o c i a l and p r i v a t e i n c e n t i v e s t o merge, a c c o u n t i n g f o r the f a c t t h a t mergers a l t e r the d i s t r i b u t i o n o f outputs a c r o s s f i r m s as w e l l as the aggregate output l e v e l . We f i n d t h a t s m a l l f i r m s t y p i c a l l y have i n s u f f i c i e n t i n c e n t i v e s t o merge, while l a r g e f i r m s have e x c e s s i v e i n c e n t i v e s t o do so. In one r e a s o n a b l e s p e c i a l case, a merger i s s o c i a l l y more a t t r a c t i v e t h e more c o n c e n t r a t e d i s p r o d u c t i o n among t h e n o n - p a r t i c i p a n t f i r m s . JEL Classification:

/pdf/horizontal-mergers-an-equilibrium-analysis-2jpbhclbkd.pdf

In a network industry, each firm must decide whether or not it wants its product to be compatible with those of rivals. This horizontal compatibility strategy determines whether competition is a battle to establish a standard or the more conventional competition within a standard. The two forms of competition involve different tactics and may differ in the extent to which they dissipate industry profits. In some cases, all firms in an industry may prefer the same form of competition. In other cases, firms may prefer different forms of competition and either may prevail.

https://pubs.aeaweb.org/doi/pdfplus/10.1257/jep.8.2.117

Joseph Farrell

Papers

Standardization, compatibility, and innovation

Installed base and compatibility : innovation, product preannouncements and predation

Horizontal Mergers: An Equilibrium Analysis

Horizontal Mergers: An Equilibrium Analysis

Choosing How to Compete: Strategies and Tactics in Standardization