Showing papers in "Journal of Institutional and Theoretical Economics-zeitschrift Fur Die Gesamte Staatswissenschaft in 2005"

Incentives in Tournaments with Endogenous Prize Selection

Abstract: Tournament incentive schemes offer payments dependent on relative performance and are intended thereby to motivate agents to exert productive effort. Unfortunately, however, an agent may also be tempted to degrade the production of his competitors in order to improve the own relative position. We investigate whether this sabotage problem is mitigated in a repeated interaction between the agents and the principal. As sabotage can hardly be observed in real-world organizations, we employ a controlled experiment. Our data provide clear evidence that agents' behavior is not only guided by competition between agents but also by the possibility of punishing the principal via sabotage.

Organizational Forms and Measurement Costs

Abstract: Under caveat emptor, buyers effect their measurements prior to exchange. Long-term relations and contracts allow buyers to measure commodities at consumption. Buyers use subjective measurements in long-term relations. Contractual guarantees shift enforcement to the state, but require objective, verifiable measurements. Most exchange agreements combine the two forms and benefit from the comparative advantage that each provides. Vertical integration reduces excessive measurement because employees gain little from manipulating commodities and information about them. The capture of quasi rent from specialized assets is just a manifestation of difficult-to-measure entities. The notion of measurement cost is more general and more operational than that of specific assets.

Judgment proofness under four different precaution technologies

Abstract: This study shows that the effects of judgment proofness on precaution depend on whether the injurer can reduce the probability of the accident, the magnitude of the harm, or both. Different legal solutions to the problem are examined: punitive damages, average compensation, undercompensation, accurate compensation, and negligence. We find that when the injurer can only reduce the probability of the accident, negligence with average compensation is the best solution, but negligence with perfectly compensatory damages is the desirable solution if the injurer can only or also affect the magnitude of the harm.

Optimal Transparency and Risk-Taking to Avoid Currency Crises

Abstract: This paper reconsiders a central bank's problem of determining rules for information dissemination and risk-taking behavior that minimize the probability of currency crises. In a global-games approach, we find that optimal transparency is adversely related to prior market beliefs. In countries with pessimistic prior beliefs about economic performance, the central bank should commit to disclosing information with maximal precision. In addition, it should increase the risk of economic performance. For good prior expectations, posterior information should be of lower precision, depending on the variance of fundamentals. Here, the central bank can reduce the crisis probability by reducing that variance.

Governmental Action, Social Norms, and Criminal Behavior

Abstract: This article explores the relationship between governmental deterrence, crime, and the strength of social norms against crime. Based on experimental research in psychology and economics, I argue that the strength of the social norm of "not committing a crime" is shaped by social interactions. Modeling these social interactions exhibits self-reinforcing processes of crime and multiple equilibria. As for the impact of governmental deterrence, I show that harsher governmental deterrence reduces crime directly as well as indirectly through its impact on social norms.

Power of Incentives in Public Organizations When Employees Are Intrinsically Motivated

Abstract: This paper studies the power of incentives in public organizations when some employees are intrinsically motivated to deliver the socially desirable outcome, while others are only driven by extrinsic incentives. To alleviate agency problems, the standard moral-hazard model suggests the use of instruments such as performance pay. This intervention might interact with intrinsic motivation. I introduce intrinsic motivation into the standard multiple-task moral-hazard model, and identify conditions under which extrinsic incentives lead to crowding in or crowding out of intrinsic motivation. The optimal reward structure shifts away from the use of monetary incentives when more employees are intrinsically motivated.

Organization of Markets for Science and Technology

Abstract: The traditional concentration of basic research activities in academic settings, with applied research more prevalent in industrial settings, is a distinguishing feature of science and technology markets. This structure arises from a unique combination of product characteristics, and in turn it influences incentives, contractual relationships, and conduct associated with research efforts by organizations and individuals. We propose a conceptual framework that combines ongoing advances in the economics of internal organization with the familiar structure-conduct-performance paradigm. The observed workings of research markets, including responses to recent policy initiatives encouraging collaborative research efforts, are best understood in the context of this comprehensive framework.

Deterrence vs. Judicial Error: A Comparative View of Standards of Proof – Comment

Abstract: We argue that the common-law standard of proof, given the rules of evidence, does not minimize expected error as usually argued in the legal literature, but may well be efficient from the standpoint of providing maximal incentives for socially desirable behavior By contrast, civil law's higher but somewhat imprecise standard may be interpreted as reflecting a trade-off between providing incentives and avoiding judicial error per se In our model, the optimal judicial system has rules resembling those in the common law when providing incentives is paramount When greater weight is given to avoiding error, the optimal system has civil-law features

A Knight without a Sword? The Effects of Audit Courts on Tax Morale

Abstract: The intention of this paper is to analyse how audit courts affect tax morale, controlling in a multivariate analysis for a broad variety of potential factors. Switzerland, with its variety of audit-court competence among the cantons, has been analysed. With data from the ISSP [1998] (Swiss data 1999), evidence has been found that higher audit-court competence has a significantly positive effect on tax morale. Thus, the results in Switzerland suggest that in the cantons where audit courts are not just knights without swords; they help improve taxpayers' tax morale and thus citizens' intrinsic motivation to pay taxes.

Information and Externalities in Sequential Litigation

Abstract: The information created and disseminated through the litigation process can have social value. Suppose a long-lived plaintiff is suing a defendant for damages sustained in an accident. The plaintiff may suffer similar damages in future accidents involving different defendants. Potential injurers update their beliefs after observing the first case and subsequently fine-tune their precautions to avoid accidents. The joint incentive of the plaintiff and the first defendant to create public information through litigation is too small. The optimal liability rule trades off the injurers' incentives to take precautions and the plaintiff's incentive to create public information.

Purchase, Patronage, and Professions: Incentives and the Evolution of Public Office in Pre-Modern Britain

Abstract: Prior to the 19th century virtually all European civil appointments were made through outright sale or patronage, and the offices were effectively private property. During the first half of the 19th century almost all of these offices converted to professional bureaucracies with salaried employees. This paper explains the choice over purchase and patronage prior to 1800, and the later transition to professions, using the NIE hypothesis that the crown was interesting in maximizing the value of its offices, and therefore, its own treasury. This hypothesis is tested by examining three branches of the British civil service: the military, judiciary, and treasury.

Decision Rules in a Judicial Hierarchy

Abstract: In this paper, we pursue further the consequences of litigant selection on the structure of judicial hierarchies. In a prior paper (Cameron and Kornhauser 2005), we constructed a simple model in which, under reasonable circumstances, the optimal judicial hierarchy had three tiers: a trial court, an intermediate appellate court and a supreme court. In that model, litigant selection of appeals creates a striking set of incentives. First, if a party knows it has lost improperly, it has a strong incentive to appeal, at least if the higher court is at all likely to correct the lower court’s error. But the incentive to appeal an improper judgment is true at any level in the judicial hierarchy below the highest level. Therefore, a correctly winning litigant has a strong incentive to contest “improper” appeals by a correctly losing litigant, if the correct loser improperly prevails on appeal. Knowing this, a correctly losing litigant has little incentive to appeal in the first place. From this perspective, the Anglo-American system of appeals implicitly pits the two litigants against one another, encouraging them to police one another’s improper appeals. As a consequence, the appellate process quickly sorts the litigants properly. In this essay we examine the importance of litigant knowledge on the efficacy of litigation selection and the choice of decisional rules at the trial and appellate levels. Specifically, we weaken the assumption that the trial reveals to both litigants the appropriate decision in the case even when the court remains ignorant. A three-tiered

Stock Options and Dividend Protection

Abstract: Stock-option programs (SOPs) became the dominant compensation instrument for top management in the nineties. Usually, they are not dividend-protected, i.e., any dividend payout decreases the value of a manager's options. Empirical evidence shows that this results in a significant decrease in the level of corporate dividends and, at the same time, in an increase in share repurchases. This paper analyzes different forms of dividend protection and addresses the importance of dividend protection in SOPs. Finally, the paper relates the theoretical analysis to empirical work on the link between share repurchases and SOPs.

Conjectural variations and evolutionary stability : A new rationale for consistency

Abstract: Adopting an evolutionary approach, we explain the conjectural variations firms may hold in duopoly. Given conjectures, firms play the market game rationally. Success in the market game determines fitness in the evolutionary game. Based on linear heterogeneous Cournot and Bertrand competition models, we show that the unique conjectures that are evolutionarily stable are consistent in that they anticipate the rival's behavior correctly.

Market Size, Technology Choice, and the Existence of Free-Entry Cournot Equilibrium

Abstract: This article adds technology choice to a free-entry Cournot model with linear demand and constant marginal costs. Firms can choose from a discrete set of technologies. This simple framework yields the nonexistence of (pure-strategy) equilibrium and the existence of multiple equilibria and equilibria in which ex ante identical firms choose different technologies, as possible outcomes. The (non)existence problem disappears if the vertical market size is large. Nonexistence is largely a small-number phenomenon. Asymmetric equilibria emerge either because of indivisibilities or because of similarity of different technologies in the average costs realized.

General and Specific Legal Rules

Abstract: Legal rules may be general (that is, applicable to a broad range of situations) or specific. Adopting a custom-tailored rule for a specific activity permits the regulator to make efficient use of information about the social costs and benefits of that activity. However, the rule maker typically relies on the regulated parties for such information. The regulated parties may attempt to influence the rule maker, producing rules that reflect their private interests. We show that in some cases limiting the rule maker to a single rule for multiple activities will moderate this influence and maximize welfare.

Trading on Short-Term Information

Abstract: This paper shows that investors may want fund managers to acquire and trade on short-term instead of more profitable long-term information. This improves learning about managerial ability from performance observations, for two reasons. Firstly, short-term information is of higher quality, which allows the investor to draw sharper inferences over a manager's type. Secondly, performance observations under long-term informed trade are contaminated by noise contained in prices, which further weakens inference. The paper thus explicitly links the degree of short-term information dissemination to the profitability and the learning implications of short-term versus long-term informed trading.

Moral cost, commitment, and committee size

Abstract: Consider a committee that in the past has made a promise not to confiscate the profits from a foreign investor. After the investment has taken place, there is a material benefit if the committee decides to default on the earlier promise. But there are also some small moral costs for those who vote in favor of default. We show that in such situations small committees are more likely to default than large committees. Thus, constituencies can decide about degrees of commitment by choosing committee sizes appropriately. Experimental data confirms our predictions.

The Pure Theory of Multilateral Obligations

Abstract: This paper develops the pure theory of damage rules that internalize external effects in a multiparty setting. Desirable properties in terms of efficiency are shown to follow from a simple saddle-point property, which, in turn, is implied by general principles of liability. The legal practice of granting compensation of negative but not positive effects turns out to be consistent with the saddle-point property. The sharing of damage payments among several injurers is not restricted by efficiency considerations. For sequences of events that follow an injury, the pure theory would grant recovery even to parties that suffer at the far end of the sequence.

Entrepreneurs and the Choice of Limited Liability

Abstract: We investigate factors influencing the choice of liability status by the owners of start-up firms. We propose a theoretical model that encompasses risk aversion, as well as differentials across liability states in the cost of capital and tax rates, as reasons why entrepreneurs choose one liability status over another. The likelihood of observing limited liability is predicted to be concave in the project size and the financial wealth of the entrepreneur. We use a recently collected data set on German start-up firms to test the model and find strong support for the model's predictions.

Adverse selection in the annuity market when payoffs vary over the time of retirement

Abstract: This study deals with a specific implication of adverse selection for annuity pricing. Varying the time path of the payoffs over the retirement periods affects the annuity demand and welfare of individuals with low and with high life expectancy in different ways. Therefore they can be separated by insurance firms through appropriate contract offers. We show that in this framework a Nash-Cournot equilibrium may not exist; if one exists, it will be a separating equilibrium. On the other hand, even if a separating equilibrium does not exist, a Wilson pooling equilibrium exists.

Chinese Sojourn Labor and the American Transcontinental Railroad

Abstract: This paper considers the institutional arrangements and labor market forces that interacted in the construction of America's transcontinental railroad. The demand for Chinese laborers on the transcontinental railroad was a product of a complex set of relationships, including the transaction costs of turnover costs, labor queuing and demand-side learning. Institutions that facilitated the supply of Chinese workers included the Chinese Six Companies. The influences of external factors, such as the discovery of gold in California, construction of America's transcontinental railroad, and racial prejudice are also considered.

General and Specific Rules: Comment

Abstract: Which is better: general or specific rules? Throughout legal history, this has been debated. German legal history offers examples for two extreme solutions: The Preuisches Allgemeines Landrecht wanted to offer a ready-made solution for every conceivable conflict. The Zivilgesetzbuch of the former German Democratic Republic wanted to get rid of doctrinal intricacies by boiling all civil law down to little more than 200 paragraphs. Ironically, both legislators claimed their intervention would make law more accessible to its addressees. Mahoney and Sanchirico [2005] add a new and important dimension to the debate. They interpret general rules as a tool that may, but need not, help a benevolent legislator reduce the detrimental effects of lobbying. This comment claims that the main result of the paper can be generated with a simpler model (section 2). With small extensions, the ecological validity of the model can even be increased (section 3).

Fair Wages, Worker Motivation and Implicit Bargaining Power in Segmented Labor Markets

Abstract: This paper addresses implicit bargaining power within employment relationships using a versatile model of labor market segmentation that combines labor discipline, performance pay, insider power, and fair wage principles. In the primary sector, fair wage comparisons, firm-specific human capital, and less perfect monitoring engender bilateral bargaining power, yielding high compensation, sometimes including a bonus. Secondary-sector employers exert unilateral bargaining power, via credible dismissal threats with no replacement costs, and offer no bonuses. Differential determinates of implicit bargaining power can potentially explain various phenomena, including nominal wage rigidity, union wage differentials, job-specific wage differentials, and gender or race-based wage differentials.

The Political Economy of Tariffs and Environmental Standards

Abstract: This paper highlights the effects of the structures of games on interest groups' lobbying behavior. When policies are determined simultaneously, environmentalists prefer a higher tariff and a stricter environmental product standard, in order to hinder imports of a good that generate negative consumption-type externalities. In a sequential game, where the tariff is determined first, environmentalists will attempt to reduce the tariff. A reduction in the tariff tightens the environmental standard, which has a stronger trade-restrictive effect. To take advantage of the stronger trade-restrictive effect of environmental regulation, environmentalists will strategically lobby for a lower tariff barrier.

Optimal Global Patent Design

Abstract: The optimal patent breadth and length is derived for an innovating and a noninnovating country in the presence of imitation. It is found that the innovating country chooses longer or broader patent protection than the noninnovating country depending on the concavity or convexity of demand. These patents are compared to the optimal global patents designs and are found to be too weak from a global perspective. Finally, it is shown that where the optimal global patent design involves identical patents in each country that the innovating country is unambiguously better off, while the noninnovating country may be worse off with the optimal global patent design.

Organizational Flexibility and Cooperative Task Allocation among Agents

Abstract: We compare rigid and flexible organizations when side contracting among agents is possible. Within a rigid organization, each agent can produce only one component of the final product, whereas within a flexible organization, the agents can reallocate their tasks during the production period. In our model, the principal can only observe the joint output produced by the agents. Our analysis reveals that within a flexible organization, side transfers are exchanged between the agents in equilibrium, and not only an efficient agent but also an inefficient agent may acquire a rent. Yet, the principal's payoff is higher when the organization is flexible, as the agents' rent-seeking behavior generates a more efficient production technology.

What is Crime

Abstract: This article asks which wrong doings should be considered criminal and which should be handled in some different manner. The answer is that when the state's commitment power is needed to provide deterrence, a wrong doing should be considered criminal. When, however, private parties can take actions that help them commit, such as write contracts or take precautions, then it could be better to have the resolution of wrong doings pursued privately.

Deterrence versus Judicial Error: A Comparative View of Standards of Proof

Abstract: The paper (Demougin and Fluet [2005]) provides an interesting insight into the functioning of standards of proof in common law and rejects the hypothesis that rules on such standards of proof are beneficial because of error minimization. Standards of proof combined with certain exclusionary rules do not lead to error minimization, as the authors are able to prove in their model; they rather lead to strengthening deterrence, and thus are socially beneficial by providing incentives to exercise due