Optimality of linearity with collusion and renegotiation

This study analyzes a continuous-time N-agent Brownian hidden-action model with exponential utilities, in which agents' actions jointly determine the mean and the variance of the outcome process. In order to give a theoretical justi¯cation for the use of linear contracts, as in Holmstrom and Milgrom (1987), we consider a variant of its generalization given by Sung (1995), into which collusion and renegotiation possibilities among agents are incorporated. In this model, we prove that there exists a linear and stationary optimal compensation scheme which is also immune to collusion and renegotiation.Principal-agent problems; moral hazard; linear contracts; continuous-time model; Brownian motion martingale method; collusion,; renegotiation; team

Incentives under collusion in a two-agent hidden-action model of a financial enterprize

This study analyzes collusion in an enterprize in which concerns about hedging cannot be ignored. In our two-agent single-task hidden-action model, where all the parties involved have exponential utility functions and the principal owning normally distributed observable and verifiable returns is restricted to o®er linear contracts, agents may exploit all feasible collusion opportunities via enforceable side contracts. Hence in general, an optimal incentive compatible and individually rational contract is not necessarily immune to collusion. We demonstrate that collusion may be ignored when making the agents work with the highest effort profile is profitable for the principal and either of the following holds: (1) mean of the return is only a®ected by the first agent's effort level, whereas variance of that is only affected by the second agent's, (2) mean is increasing and variance is decreasing separately in effort levels of both of them. On the other hand, for situations in which any of these assumptions are violated, numerical examples, showing that collusion may make the principal strictly worse off, are provided. For the justification of linear contracts as was done in the model of Holmstrom and Milgrom (1987) we consider a variant of its generalization given by Sung (1995), into which collusion possibilities are incorporated. In that continuous-time repeated agency problem including collusion, we prove the optimality of linear contracts

Optimality of linearity with collusion and renegotiation

This study analyzes a continuous-time N-agent Brownian hidden-action model with exponential utilities, in which agents' actions jointly determine the mean and the variance of the outcome process. In order to give a theoretical justification for the use of linear contracts, as in Holmstrom and Milgrom (1987), we consider a variant of its generalization given by Sung (1995), into which collusion and renegotiation possibilities among agents are incorporated. In this model, we prove that there exists a linear and stationary optimal compensation scheme which is also immune to collusion and renegotiation

Correlated Equilibrium Under Costly Disobedience

In this paper, we extend Aumann's (1974) well-known solution of correlated equilibrium to allow for a cost of disobedience for each player. Calling the new solution costly correlated equilibrium (CCE), we derive the necessary and sufficient conditions under which the set of CCE strictly expands when the players' cost of disobedience is increased by the mediator in any finite normal-form game. These conditions imply that for any game that has a Nash equilibrium (NE) that is unpure, the set of CCE strictly expands with the addition of even arbitrarily small cost of disobedience, whereas for games that have a unique NE in pure strategies, the set of CCE stays the same unless the cost gets sufficiently high. We also study the welfare implications and changes in the value of mediation with exogenous cost changes. We find that strictly better social outcomes can be attained and the value of mediation cannot decrease with an increase in the cost level. We also illustrate how our model can be integrated with a cost-selection game where players non-cooperatively choose their costs of disobedience before mediation occurs. We show that there exist cost-selection games in which setting the cost of disobedience at zero is a strictly dominated strategy for each player as well as games this strategy becomes weakly dominant for everyone

Correlated Equilibrium Under Costly Disobedience

In this paper, we extend Aumann's (1974) well-known solution of correlated equilibrium to allow for a cost of disobedience for each player. Calling the new solution costly correlated equilibrium (CCE), we derive the necessary and sufficient conditions under which the set of CCE strictly expands when the players' cost of disobedience is increased by the mediator in any finite normal-form game. These conditions imply that for any game that has a Nash equilibrium (NE) that is unpure, the set of CCE strictly expands with the addition of even arbitrarily small cost of disobedience, whereas for games that have a unique NE in pure strategies, the set of CCE stays the same unless the cost gets sufficiently high. We also study the welfare implications and changes in the value of mediation with exogenous cost changes. We find that strictly better social outcomes can be attained and the value of mediation cannot decrease with an increase in the cost level. We also illustrate how our model can be integrated with a cost-selection game where players non-cooperatively choose their costs of disobedience before mediation occurs. We show that there exist cost-selection games in which setting the cost of disobedience at zero is a strictly dominated strategy for each player as well as games this strategy becomes weakly dominant for everyone

Truth-telling and Trust in Sender-receiver Games with Intervention

Recent experimental studies find excessive truth-telling in strategic information transmission games with conflictive preferences. In this paper, we show that this phenomenon is more pronounced in sender-receiver games where a truthful regulator randomly intervenes. We also establish that intervention significantly increases the excessive trust of receivers.Strategic information transmission, truth-telling, trust, sender-receiver game.

Team beats collusion

This paper analyzes optimal contracts in a linear hidden-action model with normally distributed returns possessing two moments that are governed jointly by two agents, who can observe each others' effort levels and draft enforceable side-contracts on chosen effort levels and realized returns. After showing that standard constraints, resulting in incentive-contracts, may fail to ensure implementability, we examine (centralized) collusion-proof contracts and (decentralized) team-contracts. We prove that optimal team-contracts provide the highest implementable returns to the principal. In other words, the principal may restrict attention to outsourcing/decentralization without any loss of generality. Moreover, situations in which incentive-contracts are collusion-proof, thus implementable, are fully characterized

Team beats collusion

This paper analyzes optimal contracts in a linear hidden-action model with normally distributed returns possessing two moments that are governed jointly by two agents, who can observe each others' effort levels and draft enforceable side-contracts on chosen effort levels and realized returns. After showing that standard constraints, resulting in incentive-contracts, may fail to ensure implementability, we examine (centralized) collusion-proof contracts and (decentralized) team-contracts. We prove that optimal team-contracts provide the highest implementable returns to the principal. In other words, the principal may restrict attention to outsourcing/decentralization without any loss of generality. Moreover, situations in which incentive-contracts are collusion-proof, thus implementable, are fully characterized

Correlated Equilibrium Under Costly Disobedience

In this paper, we extend Aumann's (1974) well-known solution of correlated equilibrium to allow for a cost of disobedience for each player. Calling the new solution costly correlated equilibrium (CCE), we derive the necessary and sufficient conditions under which the set of CCE strictly expands when the players' cost of disobedience is increased by the mediator in any finite normal-form game. These conditions imply that for any game that has a Nash equilibrium (NE) that is unpure, the set of CCE strictly expands with the addition of even arbitrarily small cost of disobedience, whereas for games that have a unique NE in pure strategies, the set of CCE stays the same unless the cost gets sufficiently high. We also study the welfare implications and changes in the value of mediation with exogenous cost changes. We find that strictly better social outcomes can be attained and the value of mediation cannot decrease with an increase in the cost level. We also illustrate how our model can be integrated with a cost-selection game where players non-cooperatively choose their costs of disobedience before mediation occurs. We show that there exist cost-selection games in which setting the cost of disobedience at zero is a strictly dominated strategy for each player as well as games this strategy becomes weakly dominant for everyone