Dynamic Contracting under Permanent and Transitory Private Information

To understand how firms create and maintain long term relationships with consumers, or how procurement relations evolve over time, it is useful to study a dynamic variant of the classical two-type-buyer contract in mechanism design. It is less trivial and more interesting if the utility determinant (or utility type) is not fixed or completely random, and fair assumptions are that it is either stochastic, or given by a distribution whose parameters are common knowledge. The first approach is that of Battaglini (2005), while the second is pursued in this paper. With two possible types of buyers, the buyer more likely to have a high utility type will receive the first-best allocations, while the other will receive the first best only if he has the high utility type

Dynamic Contracting under Permanent and Transitory Private Information

To understand how firms create and maintain long term relationships with consumers, or how procurement relations evolve over time, this paper examines a dynamic variant of the classical two-type-buyer contract with commitment in mechanism design. The utility determinant (or utility type) is not fixed nor completely random, and fair assumptions are that it evolves stochastically, or it is given by a distribution whose parameters are common knowledge. The second approach is pursued in this paper, and the distribution of the utility type is determined by a private information buyer type. With two possible types of buyers, the buyer more likely to have a high utility type will receive the first-best allocations, while the other will receive the first best only if he has the high utility type

Long Term Contracting in a Changing World

I study the properties of optimal long-term contracts in an environment in which the agent’s type evolves stochastically over time. The model stylizes a buyer-seller relationship but the results apply quite naturally to many contractual situations including regulation and optimal income-taxation. I …first show, through a simple discrete example, that distortions need not vanish over time and need not be monotonic in the shock to the buyer’s valuation. These results are in contrast to those obtained in the literature that assumes a Markov process with a binary state space e.g. Battaglini, 2005. I then show that the study of the dynamics of the optimal mechanism can be significantly simplified by assuming the shocks are independent over time. When the sets of possible types in any two adjacent periods satisfy a certain overlapping condition (which is always satisfied with a continuum of types) and some additional regularity conditions hold, then the optimal mechanism is the same irrespective of whether the shocks are the buyer’s private information or are observed also by the seller. These conditions are satisfied, for example, in the case of an AR(1) process, a Brownian motion, but also when shocks have a multiplicative effect as it is often the case in financial applications. Furthermore, the distortions in the optimal quantities are independent of the distributions of the shocks and, when the buyer’s payoff is additively separable, they are also independent of whether the shocks are transitory or permanent. Finally, I show that assuming the shocks are independent not only does it greatly simplify the analysis, it is actually without loss of generality.asymmetric information, stochastic process, dynamic mechanism design, long-term contracting

Self-Enforcing Labour Contracts and the Dynamics Puzzle

To properly account for the dynamics of key macroeconomic variables, researchers incorporate various internal-propagation mechanisms in their models. In general, these mechanisms implicitly rely on the assumption of a perfect equality between the real wage and the marginal product of labour. The author proposes a theoretical validation of a micro-founded internal-propagation mechanism: he builds a model that features a limited-commitment economy, and derives endogenous self-enforcing labour contracts that produce a different linkage between the real wage and the marginal product of labour. The risk-sharing between the entrepreneur and the worker, both faced with enforcement problems, provides an admissible explanation of the prolonged comovements observed between consumption and labour. Since these co-movements are at the core of the persistence of the impulse response of output to exogenous technology shocks, this persistence can, in turn, be rationalized with the endogenous real rigidity emerging from the economy. The author shows that, in this framework, the persistence ultimately depends on the initial bargaining power and the magnitude of the risk-sharing.Business fluctuations and cycles; Economic models; Labour markets