Only time will tell: A theory of deferred compensation (with Roman Inderst and Marcus Opp), Review of Economic Studies (accepted).
Abstract: This paper characterizes optimal compensation contracts in principal-agent settings where the agent's action has persistent effects. As additional informative signals arrive over time, deferred compensation has the benefit of exploiting better performance measurement which, for any information environment, is captured by the martingale property of the likelihood ratio process. With bilateral risk-neutrality and a relatively impatient agent, optimal contracts are high-powered and feature at most two payout dates regardless of the nature of information arrival. If the agent is additionally risk-averse, rewards are paid out if and only if performance is above a hurdle that is gradually increasing over time. Our precise characterization allows for clear-cut comparative statics predictions on how the timing of pay depends on the nature of information arrival as well as agent characteristics and generates implications for the optimal duration of compensation packages and the maturity structure of claims in financial contracting settings.
Persuasion through Selective Disclosure: Implications for Marketing, Campaigning, and Privacy Regulation (with Roman Inderst and Marco Ottaviani), Management Science (forthcoming).
Abstract: This paper introduces a modeling framework to study selective disclosure of information by firms or political campaigners (senders), based on the personal information that they acquire about the preferences and orientations of consumers and voters (receivers). We derive positive and normative implications depending on: the extent of competition among senders, whether receivers are wary of senders collecting personalized data, and whether firms are able to personalize prices. We show how both senders and receivers can benefit from selective disclosure. Privacy laws requiring senders to obtain consent to acquire personal information that enables such selective disclosure increase receiver welfare if and only if there is little or asymmetric competition among senders, when receivers are unwary, and when firms can price discriminate.
Abstract: We consider an economy where production generates externalities, which can be reduced by additional firm level expenditures. This requires firms to raise outside financing, leading to deadweight loss due to a standard agency problem vis-à-vis outside investors. Policy is constrained as firms are privately informed about their marginal cost of avoiding externalities. We first derive the optimal linear pollution tax, which is strictly lower than the Pigouvian tax for two reasons: First, higher firm outside financing creates additional deadweight loss; second, through redistributing resources in the economy, a higher tax reduces average productive efficiency. We analyze various instruments that achieve a more efficient allocation, in particular, nonlinear pollution taxes, which can no longer be implemented through a tradable permit scheme alone, and grants tied to loans, which are frequently observed in practice.
Abstract: In markets as diverse as that for specialized industrial equipment or that for retail financial services, sellers or intermediaries may earn profits both from the sale of products and from the provision of pre-sale consultation services. We study how a seller optimally chooses the costly quality of pre-sale information, next to the price of information and the product price, and obtain clear-cut predictions on when information is over- and when it is underprovided, even though we find that information quality does not satisfy a standard single-crossing property. Buyers who are a priori more optimistic about their valuation end up paying a higher margin for information but a lower margin for the product when they subsequently exercise their option to purchase at a pre-specified price.
Supplement with some additional material: Supplement to "Pre-Sale Information".
Older (working paper) version: Price Discrimination and the Provision of Information.
Abstract: This article studies a continuous time principal-agent problem of a firm whose cash flows are determined by the manager's unobserved effort. The firm's cash flows are further subject to persistent and publicly observable shocks that are beyond the manager's control. While standard contracting models predict that compensation should optimally filter out these shocks, empirical evidence suggests otherwise. In line with this evidence, our model predicts that the manager is “rewarded for luck.”
The Economics of Deferral and Clawback Requirements: An Indirect Tax Approach to Compensation Regulation (with Roman Inderst and Marcus Opp), r&r Journal of Finance, EFA 2019, WFA-CFAR 2019 Meetings Paper.
Abstract: We propose an indirect tax approach to analyze the effects of regulatory interference in compensation contracts, focusing on recent mandatory deferral and clawback requirements in the financial sector. Different from capital requirements, compensation regulation does not directly target bank shareholders' preferences over risk choices but only indirectly via its effect on compensation costs. Whether moderate deferral requirements induce shareholders to incentivize higher risk-management depends on fundamentals governing compensation design, such as the information environment or managers' outside options, whereas stringent deferral requirements unambiguously backfire. We characterize socially optimal deferral and clawback requirements and their interaction with capital regulation.
Dynamic Multitasking and Managerial Investment Incentives (with Sebastian Pfeil), r&r (2nd round) Journal of Financial Economics, AFA 2015 Meetings Paper.
Abstract: We study long-term investment in a dynamic agency model with multitasking. The manager’s short-term task determines current performance which deteriorates if he invests in the firm's future profitability, his long-term task. The optimal contract dynamically balances incentives for short- and long-term performance such that investment is distorted upwards (downwards) relative to first-best in firms with high (low) technological returns to investment. These distortions decrease as good performance relaxes the endogenous financial constraints arising from the agency problem, implying negative (positive) investment-cash flow sensitivities. Investment distortions and cash flow sensitivities increase in absolute terms with short-term performance pay and external financing costs.
Regulating Cancellation Rights with Consumer Experimentation (with Roman Inderst and Sergey Turlo), EEA 2017 Meetings Paper.
Abstract: This paper analyzes the welfare implications of regulating consumers' rights of product return and contract cancellation. The key feature of our model of consumer experimentation is that, after returning a product, consumers turn back to the market and thereby exert a positive pecuniary externality on other firms. As a consequence, in the unregulated market equilibrium, there are always too few such cancellations and returns. A mandatory extension of consumers' rights of cancellation and return, in the form of commonly observed statutory minimum refund periods, increases efficiency only when consumers' share of the surplus is low, and it exacerbates the market failure when it is high. We also show that the generosity of consumers' cancellation rights is not a good predictor of market performance or competition in the market.
Disliking to Disagree (with Kiryl Khalmetski and Mark T. Le Quement) - new version coming soon, EEA 2018 Meetings Paper.
Abstract: Abundant experimental and field evidence suggests that people tend to dislike open disagreement. We propose a formalization of perceived disagreement and study the implications of perceived disagreement aversion in disclosure games involving agents with different priors. Across a variety of settings, the ideal conditions for disclosure involve identical prior variances and differing prior means. When equilibrium disclosure is partial, it is biased towards evidence that is congruent with the most confident agent's prior bias. Perceived disagreement aversion leads to assortative matching in prior beliefs that provides a theoretical basis for echo chambers. Equilibria may feature higher average perceived or actual disagreement than a hypothetical full disclosure scenario. Perceived disagreement aversion arises endogenously within simple games of delegation and competitive authority assignment.