Imperfect Auditing, Appeals, and Limited Liability

We examine the effect of an imperfect audit and a subsequent appeals process in a standard adverse selection problem when legal or institutional restrictions impose an upper bound on penalties. We show that the imperfect audit always reduces the agent\u27s information rent and enhances efficiency despite the limited liability. A subsequent appeals process, which allows the agent to challenge an unfavorable finding by the audit, is never optimal when it is costless. However, when the appeals process is costly, it can be optimal even if it is less accurate than the audit. Moreover, social welfare can increase as the cost of the appeals process increases

The Appeals Process in Principal–Agent Relationships

The appeals process is employed in many organizations, including administrative agencies, regulatory authorities, sports organizations, and private companies. This paper examines the dual role of the appeals process in correcting errors and inducing compliance in principal-agent relationships in the presence of imperfect performance evaluation. Some surprising results emerge. For example, appeals may be denied even if the appeals process is quite accurate and costless. An increased accuracy of initial observation may reduce welfare. Furthermore, welfare can increase as the cost of the appeals process increases

Delegating Procurement to Experts

Buyers frequently delegate purchase decisions to sellers who are better informed about supply options and the cost of service. This paper analyzes how buyers optimally contract with sellers who vary in their expertise at prescribing service. We show that the most expert suppliers offer the greatest variation in advice. Buyers benefit from dealing with experts provided they contract sequentially whereby terms are negotiated gradually as the supplier acquires informationprocurement, contract, information structures

Regulating a Risk-Averse Firm Under Incomplete Information

We examine the optimal regulatory policy for a risk-averse firm when the firm is imperfectly informed about its efficiency parameter for a project at the time of contracting. The firm\u27s risk aversion shifts the optimal regulatory policy from a fixed-price contract to a cost-plus contract. The optimal regulatory policy entails undereffort by an inefficient firm as in Lafont and Tirole (1986) and the effort distortion increases as the firm becomes more risk-averse. Further, the regulator benefits from sequential contracting with the firm where the firm chooses contract terms gradually as it acquires information, albeit the benefit diminishes as the firm becomes more risk-averse

Risk Sharing and Adverse Selection with Asymmetric Information on Risk Preference

We consider a principal-agent relationship where a buyer contracts with a risk-averse supplier for the production of certain good. At the time of contracting, both parties share incomplete information on cost of production. However, after contracting and before production, the supplier privately discovers its cost of production. We study the optimal contract between the two parties in the presence of cost uncertainty when the supplier is privately informed of its risk preference at the time of contracting

Optimal Contracting with Wealth-Constrained Operators of Unknown Ability

This paper examines how a project owner optimally selects a project operator and motivates him to deliver an unobservable effort when potential operators are wealth-constrained. It shows that either a pooling or a separating contract can arise in equilibrium. In a separating contract, the more capable potential operator is either selected more often but awarded a smaller share of profit, or selected less often but awarded a larger share of profit

International Joint Venture under Asymmetric Information: Technology vis-à-vis Information Advantage

We study the relationship between a multinational corporation (MNC) and a domestic firm under demand uncertainty. The MNC possesses a superior production technology, but the domestic firm is better at predicting market demand. We examine how the MNC’s preference for, and the ownership structure of, a joint venture depend on the credit market, demand uncertainty, the domestic firm’s ability to gather demand information, the MNC’s technology advantage, and the efficiency of technology transfer. We also consider a dynamic setting with technology spillover and show that whether technology spillover hinders or facilitates joint venture depends on the nature of the credit market

Managing Innovation in Vertical Relationships

We study the structure of an optimal management for innovative activities. The top management of a buyer hires a supplier for production. The production efficiency can be enhanced by investing in R&D before production. The buyer chooses between using its own subunit for the R&D, or outsourcing the task to the supplier (integration of R&D and production). Our analysis reveals that (i ) when the R&D cost is small, the buyer prefers in- house R&D, (ii ) when the R&D cost is intermediate, the buyer prefers outsourcing R&D, and (iii ) when the R&D cost is large, the buyer prefers in-house or outsourcing R&D, depending on the parameter. Within the regime in which R&D outsourcing prevails, the optimal production levels may have partial bunching for successful yet less favorable R&D results, depending on the R&D cost. Thus, motivating R&D may require that less favorable R&D results be overly and equally appreciated, unless the R&D is a failure

The Incentive Effects of Organizational Forms: Evidence from Florida’s Non-Emergency Medicaid Transportation Programs

We analyze the incentive effects of organizational forms using data from Florida’s Non-Emergency Medicaid Transportation (NEMT) programs. These programs differ in the extent to which their brokers are directly involved in providing transit services. Based on a simple model of moral hazard, we predict that the number of users and the number of claims per user of the program increase, but cost per claim of the program decreases, as its broker’s share of transit services increases. The empirical evidence supports our theoretical predictions on the incentive effects of different organizational forms