Monopoly Theory with Price-Increase Aversion
with Yuval Salant
Abstract: A consumer is averse to price increases if increasing the price of a good reduces the consumer's willingness to pay for it. We study the optimal dynamic pricing strategy of a monopolist firm in a market with price-increase averse consumers and demand shocks. The strategy is \emph{countercyclical at the bottom} in the sense that the firm charges the highest prices when demand is weak. The strategy also exhibits \emph{downward price stickiness}: when demand is such that current profit considerations entail a small price decrease, the firm refrains from doing so and keeps prices constant. Despite higher expected prices, consumer welfare in a market with strong price-increase aversion is larger than in a market without price-increase aversion. We then generalize these observations to a model of reference-dependent pricing, where the price history determines the reference price. This introduces a novel trade-off for the firm between profiting today and manipulating tomorrow's reference price.
Building and Maintaining Productive Relationships
Abstract: Productive relationships require a mutual understanding of what each party requires. We model relationship formation and termination when agents face uncertainty about which actions (if any) are productive, what we call a "clarity problem." In each period of experimentation, the agent finds a productive action with some probability; this sequence of probabilities describes clarity. Our model predicts a reversal in termination rates: agents with higher clarity are less likely to end relationships in the early search phase, but more likely to end them later, since they find productive relationships easier to replace. Using transaction-level data from Ethiopia’s rose industry, we document that clarity problems are economically significant. Moreover, exporters that are more likely to form productive relationships, those with higher clarity, are also more likely to terminate them when outside options improve. This explains why domestically owned exporters, despite lower discount factors, are less responsive to positive shocks to the outside option than foreign-owned exporters. Clarity emerges as a key determinant of relationship formation and maintenance, determining whether exporters can access the higher profitability and economic growth associated with direct sales of differentiated products.
Selected Facts
Abstract: A sender must provide facts to persuade a receiver to accept or reject a proposal. Sender-optimal strategies in this constrained information design problem correspond to maximal-weight matchings on a bipartite graph that incorporates novel fact-selection constraints. Receiver payoffs are independent of the sender's cardinal preferences, although these preferences determine the actual decisions. We show exactly when the sender can induce his ideal decisions. When the receiver can first specify a set of admissible facts, she may (not) like to eliminate the sender's freedom to select facts, and she may be able to get her own ideal decisions in some situations.
Robust Contracts: A Revealed Preference Apporach
with George Georgiadis
Accepted Review of Economics and Statistics
Abstract: We study an agency model in which the principal knows the agent-optimal actions in response to K "known" contracts but is unaware of other actions available or their costs, and seeks a contract to maximize worst-case profits. The optimal contract is a mixture of the known contracts and output. Moreover, when $K=1$, the single known contract maximizes the principal's profit guarantee, whereas with two known contracts, the optimal mixture puts positive weight on one of the known contracts. Our methodology is straightforward to implement, a point that we demonstrate using data from an experimental study of different incentive schemes.
Subversive Conversations
with Archishman Chakraborty and Rick Harbaugh
Journal of Political Economy 133(5)
Abstract: Two players with common interests exchange information to make a decision. Their communication is scrutinized by an observer with different interests who understands the meaning of all messages and may object to the decision. We show how the players can implement their optimal decision rule using a back and forth conversation. Such a subversive conversation reveals enough information for the players to determine their best decision, but not enough information for the observer to determine whether the decision was against his interest. Our results provide a theory of conversations based on deniability in the face of possible public outrage.
Optimal Banking with Delegated Monitoring
with Tai-Wei Hu
Journal of Economic Theory, 222, December 2024, 105904.
Abstract: Risk-neutral firms with risky projects require external funding from lenders. The project's realized return is private information of each firm. We study a financial intermediation with costly-state verification, where agents cannot commit to their verification strategy, there is aggregate uncertainty and lenders may be risk averse. Static bank contracts are Pareto optimal without aggregate uncertainty, but they may not be so with it. However, regulator can implement a Pareto optimal dynamic contract even with aggregate uncertainty, via a resolution mechanism that uses franchise values as threat to discipline the bank undertake costly monitoring in bad states. Bailout policy, subject to ex ante budget-balancedness, can be welfare-improving if the dynamic bank contract is not financially stable.
Equilibrium Selection Through Forward Induction in Cheap Talk Games
with Nicola Persico
Games and Economic Behavior 138, 2023
Abstract: This paper provides a refinement that uniquely selects the ex-ante Pareto dominant equilibrium in a cheap talk game, provided one exists. The refinement works by embedding any cheap talk game into a class of two-stage games where: in stage 1 sender and receiver choose their biases at a cost, and in stage 2 the cheap talk game is played. For such games, we show that a forward induction logic can be invoked to select the ex-ante Pareto-dominant equilibrium in the second stage. Games with fixed biases (the conventional cheap talk games) are then treated as limiting cases of this larger class of games.
Screening through Coordination
with Kai Steverson
Conditionally Accepted Journal of Economic Theory
Abstract: Under standard screening techniques the principal tailors her actions to the preferences associated with agents' reported types. However, in a number of natural economic situations, agents can have preferences that do not vary with their type, making this standard technique infeasible. Instead, a principal who faces multiple agents and whose preferences exhibit complementarities across those agents, can benefit by coordinating her actions. Coordination delivers a payoff gain to the principal on states with more high quality agents and accepts a payoff loss on states with more low quality agents. This strategy leverages the structure of the principal's preferences by performing well when there are strong complementarities to benefit from, and accepting a poor performance when the complementarities are weak. Coordination sometimes results in counter-intuitively favoring an agent who is inferior for the principal's own aims. This behavior, which we call favoritism, is often assumed to be inefficient and to arise from the biases of the principal. A key insight of our work is that favoritism can arise from strategic considerations and be optimal for an unbiased principal.
Cheap Talk with Endogenous Conflict of Interest
with Nicola Persico
Econometrica 88(6)
Abstract: This paper analyzes a cheap-talk setting where the conflict of interest between sender and receiver is determined endogenously by the choice of parameters θi, one for each agent, prior to the cheap talk phase. Conditions are provided that determine the sign of agent i's inverse demand for θ without assuming that the most informative equilibrium will necessarily be played in the cheap talk game. For two popular functional forms of payoffs, we derive analytically tractable approximations for agent i's demand for θ. Under the above conditions, if investors obtain shares in an enterprise by trading in an equity market, then the competitive equilibrium allocation achieves the most information transmission that is possible, given the particular equilibrium selection in the cheap talk game that follows the trading stage. However, an inefficiency lurks in the background: if the receiver's ability to trade is restricted, a competitive market for shares fails to reward the positive externality that the sender provides to other agents by purchasing his shares. In a principal-agent relationship, we show that the optimal contract will not allocate equity in a way that achieves perfect communication. A forward induction argument is offered that selects the most informative equilibrium in a generic cheap talk game when the conflict of interest is endogenous. Two extensions are briefly sketched out. First, the scenario where the θ's are acquired covertly rather than overtly. Second, the scenario in which the θ's are traded after the sender has received the information.
Beyond Delegation: Agency Discretion when Budgets Matter
with Matias Iaryczower
R&R Journal of Politics
Abstract: A fundamental result in the literature on congressional control of the bureaucracy is that optimal institutions take the form of limited delegation of decision-making authority to the agency. We revisit the question of optimal institutional design for cases in which the extent to which the policy is funded determines its effectiveness. We show that in this context, delegation is not optimal. Instead policy is almost everywhere below the agent's preferred policy. The optimal separating mechanism entails larger reductions of the budget for policies that go further in the direction of the agent's preferences; even more, in some states, than what the legislator herself would want to implement given full information.
Contracting with Unknown Technologies
Abstract: I study contracting with moral hazard when the agent has available a known (baseline) production technology but the principal thinks that the agent may also have access to other technologies, and maximizes his worst-case expected utilities under those possible technologies. The nature of the Pareto efficient contract depends on the most unproductive distribution that the principal thinks might be available to the agent. When this lower-bound technology becomes trivial and all distributions are possible, equity is a Pareto efficient contract, generalizing existing work on robust contracting. When the lower-bound MLRP technology approaches the baseline technology, efficient contracts approach debt, providing robust foundations for debt in a classic financial contracting model. For intermediate lower-bounds, participating preferred equity contracts, mixtures of debt and equity are Pareto efficient for specific technology sets.
Communication Between Shareholders
with Nicola Persico
Abstract: We study an expert shareholder who chooses how much information to communicate about a potential investment's return to a controlling shareholder who controls the investment strategy. We embed this model into two settings. In the first setting, equity ownership is determined by investors buying shares on a competitive equity market. We provide conditions under which share-trading delivers perfect communication and full risk-sharing. However, an inefficiency lurks in the background: a competitive market for shares fails to reward the positive externality that the expert investor provides to other investors by purchasing shares. The second setting is a principal-agent relationship where the equity is granted as compensation by a principal (board) to an agent (CEO). Within this setting, the model highlights a novel trade-off between incentivizing effort provision and promoting information transmission.
Note: Results in this paper are partially incorporated in "Cheap Talk with Endogenous Conflict of Interest", but the published paper also relies on some results in this working paper.
