Essays on dynamic information economics

This dissertation studies moral hazard problems and an information acquisition problem in dynamic economic environments. In chapter 1, I study a continuous-time principal-agent model in which a risk-neutral agent protected by limited liability exerts costly efforts to manage a project for her principal. Unobserved risk-taking by the agent is value-reducing in the sense that it increases the chance of large losses, even though it raises short-term profits. In the optimal contract, severe punishment that follows a large loss prevents the agent from taking hidden risks. However, after some histories, punishment can no longer be used because of limited liability. The principal allows the agent to take hidden risk when the firm is close to liquidation. In addition, I explore the roles of standard securities in implementing the optimal contract. The implementation shows that driven by the agency conflicts, incomplete hedging against Poisson risk provides incentives for the agent to take the safe project. Moreover, I study the optimality of "high-water mark" contract widely used in the hedge fund industry and find that "distance-to-threshold" is important in understanding the risk-shifting problem in a dynamic context. In chapter 2, I study a continuous-time moral hazard model in which the principal hires a team of agents to run the business. The firm consists of multiple divisions and agents exert costly efforts to improve the divisional cash flows. The firm size evolves stochastically based on the aggregate cash flows.The model delivers a negative relationship between firm sizes and pay-for-divisional incentives, and I characterize conditions under which joint/relative performance evaluation will be used. I also explore the implications of team production on the firm's optimal capital structure and financial policy. In chapter 3, I study a multi-armed bandits problem with ambiguity. Decision-maker views the probabilities underlying each arm as imprecise and his preference is represented by recursive multiple-priors. I show that the classical "Gittins Index" generalizes to a "Multiple-Priors Gittins Index". In the setting with one safe arm and one ambiguous arm, the decision-maker plays the ambiguous arm if its "Multiple-Priors Gittins Index" is higher than the return delivered by the safe arm. In the multi-armed environment, I obtain the "Multiple-Priors Index Theorem" which states that the optimal strategy for the decision-maker is to play the ambiguous arm with the highest Multiple-Priors Index

Dynamic Bonus Pools

We analyze a two-period agency problem with limited liability and nonverifiable information. The principal commits to a dynamic bonus pool comprising a fixed total payment that may be distributed over time to the agent and a third party. We find that the optimal two-period contract features memory. If the agent succeeds in the first-period, second-period incentives are weakened whereas higher-powered incentives are provided if he fails. The two-period bonus pool offers a complementary reason for why third-party payments are not commonly observed in practice

Incentives, Reputation and the Allocation of Authority

We address the question how much authority a principal should delegate to a manager with conflicting interests and uncertain ability in a context in which the manager has both compensationbased and reputational incentives. The optimal level of authority balances the value of the manager’s decision-making expertise against the cost of ensuring that the manager uses his discretion productively. Reputational incentives reduce the necessary monetary incentives to discourage purely opportunistic behavior, but may cause the manager to pursue conservative courses of action to preserve his reputation. This undermines the benefits of delegating control, leading to decreased managerial authority and stronger monetary incentives. When the principal can commit to long-term contracts, she eliminates this conservative bias by rewarding a successful manager with greater future compensation and authority than would be optimal in a static setting. Early in the relationship the principal may delegate additional authority in order to screen for managers of high ability

On Delegation under Relational Contracts

In this paper, a principal’s decision between delegating two tasks or handling one of the two tasks herself is analyzed. We assume that the principal uses both, formal contracts and informal agreements sustained by the value of future relationships (relational contracts) as incentive device. It is found that the principal is less likely to delegate both tasks in a dynamic setting than in a static one (where formal contracts are the only feasible incentive device), as handling one task herself enables a much wider use of relational contracts

Career concerns and investment maturity in mutual funds

An important puzzle in financial economics is why fund managers invest in short-maturity assets when they could obtain larger profits in assets with longer maturity. This work provides an explanation to this fact based on labor contracts signed between institutional investors and fund managers. Using a career concern setup, we examine how the optimal contract design, in the presence of both explicit and implicit incentives, affects the fund managers decisions on investment horizons. A numerical analysis characterizes situations in which young (old) managers prefer short-maturity (long-maturity) positions. However, when including multitask analysis, we find that career concerned managers are bolder and also prefer assets with long maturity

Distorted Performance Measures and Dynamic Incentives

Incentive contracts must typically be based on performance measures that do not exactly match agents’ true contribution to principals’ objectives. Such misalignment may impose difficulties for effective incentive design. We analyze to what extent implicit dynamic incentives such as career concerns and ratchet effects alleviate or aggravate these problems. Our analysis demonstrates that the interplay between distorted performance measures and implicit incentives implies that career and ratchet effects have real effects, that stronger ratchet effects or more distortion may increase optimal monetary incentives, and that bureaucratic promotion rules may be optimal.Search; Learning; Information and Knowledge; Communication; Belief; Compensation Packages; Payment Methods; Labor Management.

Adaptive Contract Design for Crowdsourcing Markets: Bandit Algorithms for Repeated Principal-Agent Problems

Crowdsourcing markets have emerged as a popular platform for matching available workers with tasks to complete. The payment for a particular task is typically set by the task's requester, and may be adjusted based on the quality of the completed work, for example, through the use of "bonus" payments. In this paper, we study the requester's problem of dynamically adjusting quality-contingent payments for tasks. We consider a multi-round version of the well-known principal-agent model, whereby in each round a worker makes a strategic choice of the effort level which is not directly observable by the requester. In particular, our formulation significantly generalizes the budget-free online task pricing problems studied in prior work. We treat this problem as a multi-armed bandit problem, with each "arm" representing a potential contract. To cope with the large (and in fact, infinite) number of arms, we propose a new algorithm, AgnosticZooming, which discretizes the contract space into a finite number of regions, effectively treating each region as a single arm. This discretization is adaptively refined, so that more promising regions of the contract space are eventually discretized more finely. We analyze this algorithm, showing that it achieves regret sublinear in the time horizon and substantially improves over non-adaptive discretization (which is the only competing approach in the literature). Our results advance the state of art on several different topics: the theory of crowdsourcing markets, principal-agent problems, multi-armed bandits, and dynamic pricing.Comment: This is the full version of a paper in the ACM Conference on Economics and Computation (ACM-EC), 201

Objective versus Subjective Performance Evaluations

Why does incentive pay often depend on subjective rather than objective performance evaluations? After all, subjective evaluations entail a credibility issue. While the most plausible explanation for this practice is lack of adequate objective measures, I argue that subjective evaluations might sometimes also be used to withhold information from the worker. I furthermore argue that withholding information is particularly important under circumstances where the credibility issue is small. The statements are derived from a two-stage principal-agent model in which the stochastic relationship between effort and performance is unknown