Guy Arie - Research Summary

This page provides a short summary of what I'm working on.

• Dynamic Costs and Moral Hazard
  The cost of effort often increases in past effort. In sales, for example, the last sales of a quarter are harder to make than the first ones -- the pool of easy customers is depleted. In an agency setting with unobservable effort, increasing marginal cost complicates the optimal contract problem. If the agent shirks today, his cost tomorrow will be lower than the principal believes. The optimal contract is characterized as a dynamic quota. The main features of the optimal contract are consistent with the popular yet thus far puzzling use of nonlinear incentives for sales agents. Historically, the main obstacle for solving dynamic moral hazard problems with private information was that the one-shot-deviation principle cannot be applied. I develop a duality based representation for dynamic moral hazard problems and use it to obtain a stronger characterization of the optimal contract. In particular, the dynamic dual analysis shows that the optimal contract does satisfy a one-shot-deviation condition.
  
  
• Do Firms Compensate Switching Consumers? with Paul Grieco
  Consumers often face a cost to switching between using a product and its alternative. Earlier work has characterized pricing in the presence of switching costs as a dilemma between a short-term harvesting incentive to increase prices versus a long-term investing incentive to lower prices. This paper shows that small switching costs may provide a short-term incentive to lower rather than increase prices. If consumers switch in equilibrium, firms may lower prices to partially offset the costs of consumers that are switching into the firm. This compensating effect of switching costs is sufficient to cause even myopic firms in symmetric oligopolies to never increase prices when small switching costs are introduced. The analysis relates the short-term effect of small switching costs to taxes and shows that, as in the case with taxes, welfare of both producers and consumers declines. Small switching costs decrease prices, profits and consumer welfare.
  The theoretic results provide a simple and intuitive explanation for recent empirical findings on the relation between switching costs and prices.
  
  
• Multi-Market Contact in the Airline Industry: Theory and Evidence with Sarit Markovich and Mauricio Varela
  For airline carriers, each pair of cities is a market. There are two senses in which a carrier's markets are inter-dependent. First, the same flight may be used to service several markets. Second, the carrier may face the same rivals in several markets. The paper shows to what degree the competitive equilibrium is affected by the degree of the carrier's flexibility (i.e., the ability to use the same flight for multiple markets), his rivals' flexibility and the extent of multi-market contract between the carrier and its rivals.
  Analysis of the US domestic airline data from the last 15 years obtains results that are consistent with the theory and suggest that airlines consider the identified effects.
  

Projects in earlier stages:

• Dynamic Costs and the Design of Organizations
  One of the insights from my job market paper is that organizational design can alleviate the private information problem. Specifically, transferring tasks between agents "kills off" any private information incentives to shirk. This paper studies this effect and characterizes an "incentive based hierarchy". The main take away is that firms may create a hierarchical structure just to limit the worker's private information.
  
  
• Dynamic Costs and Productivity: Evidence from Software Testing
  This paper was part of the motivation for the job market paper. It is well known that the productivity of testers declines rapidly with their effort on the task. To find new bugs the tester must think up new ways to use the software. Thus, incentives that increase in past effort may be required. Using a large panel from a pay-per-bug software testing firm, I find that only 20% of the reduction in observed productivity is directly caused by the increased difficulty. The remaining 80% is caused by the fact that incentives are not adjusted to compensate for the harder work.
  
• Specialization and Strategic (Re)Investment Decisions in Venture Capital (joint with Vineet Bhagwat and Yael Hochberg).
  Venture Capital reinvestment decisions may be affected by strategic considerations in addition to the direct profitability of the investment. The paper develops a model that captures such strategic considerations. The theoretic analysis provides novel empirical predictions, which we validate using VC investment data.