Contract Theory Patrick Bolton Mathias Dewatripont Oslo, August Course description (preliminary)

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1 Contract Theory Patrick Bolton Mathias Dewatripont Oslo, August 2006 Course description (preliminary) This 15-hour course provides a survey of the main achievements of contract theory. It is meant to be a first graduate course on the subject. Therefore, while it aims to cover significant recent developments in the field, it mostly stresses classic papers rather than yet unpublished work. The course relies on the book we published in 2005 with MIT Press. The philosophy of the book (and therefore of this course) is to make the reader familiar with the modeling techniques of contract theory through the use of a number of key real-world applications. The course outline is as follows: 1. Moral hazard: static one principal, one agent. 2. Moral hazard in teams, tournaments and hierarchies. 3. Dynamic moral hazard and career concerns. 4. Static adverse selection. 5. Mechanism design and auctions. 6. Dynamic adverse selection. 7. Implementation, incomplete contracts and authority. 1

2 Contract Theory Patrick Bolton Mathias Dewatripont Oslo, August 2006 General References * Bolton, P. and M. Dewatripont (2005), Contract Theory, Cambridge, Mass: MIT Press (especially chapter 1: Introduction). Hart, O. (1995), Firms, Contracts and Financial Structure, Oxford, England: Oxford University Press. Laffont, J.-J. and D. Martimort (2002), The Theory of Incentives: The Principal-Agent Problem. New York: Princeton University Press. Milgrom, P. and J. Roberts (1992). Economics, Organization and Management. Englewood Cliffs, N.J.: Prentice-Hall. Salanie, B. (1997), The Economics of Contracts: A Primer. MIT Press. 1. Moral hazard: static one principal, one agent * Bolton, P. and M. Dewatripont (2005), Contract Theory, chapter 4: Moral Hazard, and chapter 6: Multidimensional incentive problems. Grossman, S. and O. Hart (1983), An Analysis of the Principal-Agent Problem, Econometrica 51: * Holmstrom, B. (1979). "Moral Hazard and Observability." Bell Journal of Economics: 10: * Holmstrom, B. and P. Milgrom (1990), Multi-Task Principal-Agent Analyses, Journal of Law, Economics and Organization, 7, Special Issue. Jewitt, I. (1988), Justifying the First-Order Approach to Principal-Agent Problems, Econometrica 56: Mirrlees, J. (1999), The Theory of Moral Hazard and Unobservable Behavior, Review of Economic Studies 66: Rogerson, W. (1985), The First-Order Approach to Principal-Agent Problems, Econometrica 53:

3 2. Moral hazard in teams, tournaments and hierarchies * Bolton, P. and M. Dewatripont (2005), Contract Theory, chapter 8: Multiagent Moral Hazard and Collusion. Calvo, G. and S. Wellisz (1978), Supervision, Loss of Control, and the Optimum Size of the Firm, Journal of Political Economy 75: * Dewatripont, M. and J. Tirole (1999), Advocates, Journal of Political Economy, 107(1): Green, J. and N. Stokey (1983), "A Comparison of Tournaments and Contracts." Journal of Political Economy, 91: * Holmstrom, B. (1982). "Moral Hazard in Teams." Bell Journal of Economics: 13: Holmstrom, B. and P. Milgrom (1990), Regulating Trade Among Agents, Journal of Institutional and Theoretical Economics, 146(1): Itoh, H. (1991), Incentives to Help in Multi-Agent Situations, Econometrica, 59(3): Lazear, E. and S. Rosen. (1981). "Rank-Order Tournaments as Optimum Labor Contracts." Journal of Political Economy, 89: Legros, P. and S. Matthews (1993), Efficient and Nearly Efficient Partnerships, Review of Economic Studies 6): Qian, Y. (1994), Incentives and Loss of Control in an Optimal Hierarchy, Review of Economic Studies 61: Dynamic moral hazard and career concerns * Bolton, P. and M. Dewatripont (2005), Contract Theory, chapter 10: Dynamic Moral Hazard. * Chiappori, P.A., I. Macho, P. Rey and B. Salanie (1994), Repeated Moral Hazard: The Role of Memory, Commitment and the Access to Credit Markets, European Economic Review 38(8), Dewatripont, M., I. Jewitt, and J. Tirole. (1999). "The Economics of Career Concerns, Parts I & II." Review of Economic Studies 66: Fudenberg, D., Holmstrom, B. and P. Milgrom (1990), Short Term Contracts and Long Term Agency Relationships, Journal of Economic Theory, 51(1): Fudenberg, D., and J. Tirole (1990). Moral Hazard and Renegotiation in Agency Contracts, Econometrica 58(6):

4 Hermalin, B. and M. Katz. (1991). "Moral Hazard and Verifiability: The Effects of Renegotiation in Agency." Econometrica, 59(6): * Holmstrom, B. (1982). "Managerial Incentive Problems--A Dynamic Perspective." Republished in Review of Economic Studies 66 (1999): * Holmstrom, B. and P. Milgrom (1987), Aggregation and Linearity in the Provision of Intertemporal Incentives, Econometrica, 55(2) p Radner, R. (1981), Monitoring Cooperative Agreements in a Repeated Principal-Agent Relationship, Econometrica, 49(5): Rogerson, W. (1985), Repeated Moral Hazard, Econometrica, 53: Static Adverse selection Adams, W. and J. Yellen (1976), Commodity bundling and the burden of monopoly, Quarterly Journal of Economics 90: Baron, D. and R. Myerson (1982), Regulating a Monopolist with Unknown Costs, Econometrica, 50(4): * Bolton, P. and M. Dewatripont (2005), Contract Theory, chapter 2: Adverse selection: screening, and chapter 6: Multidimensional incentive problems. Laffont, J-J and J. Tirole (1986), Using Cost Observation to Regulate Firms, Journal of Political Economy, 94(3). * Maskin, E. and J. Riley (1984), Monopoly with Incomplete Information, Rand Journal of Economics, 15: Mirrlees, J. (1971), An exploration in the theory of optimum income taxation, Review of Economic Studies 38: Mussa, M. and S. Rosen (1978), Monopoly and Product Quality, Journal of Economic Theory, 18: Rochet, J.C. and L. Stole (2003), The Economics of Multidimensional Screening," in M. Dewatripont, L. Hansen and S. Turnovsky (Eds), Advances in Economics and Econometrics, Cambridge: Cambridge University Press. * Tirole, J. (1986), Hierarchies and Bureaucracies: On the Role of Collusion in Organizations Journal of Law, Economics and Organization, II(2): Tirole, J. (1992), Collusion and the Theory of Organizations, in J.-J. Laffont (ed.), Advances in Economic Theory: Sixth World Congress, Volume 2, Econometric Society, Cambridge: Cambridge University Press,

5 5. Mechanism design and auctions * Bolton, P. and M. Dewatripont (2005), Contract Theory, chapter 7: Multiagent adverse selection. Cremer, J. and R. McLean (1988), Full Extraction of the Surplus in Bayesian and Dominant Strategy Auctions," Econometrica 56, d'aspremont, C. and L. Gerard-Varet (1979), Incentives and Incomplete Information, Journal of Public Economics, 11: Maskin, E. and J. Riley (1984), Optimal Auctions with Risk-Averse Buyers, Econometrica 52(6): Milgrom, P. and R. Weber (1982), A Theory of Auctions and Competitive Bidding, Econometrica 50(5): * Myerson, R. (1981), Optimal Auction Design, Mathematics of Operations Research, 6: * Myerson, R. and M. Satterthwaite (1983), Efficient Mechanisms for Bilateral Trading, Journal of Economic Theory, 29: Dynamic adverse selection * Bolton, P. and M. Dewatripont (2005), Contract Theory, chapter 9: Dynamic Adverse Selection. Dewatripont, M. (1989), Renegotiation and Information Revelation over Time: The Case of Optimal Labor Contracts, Quarterly Journal of Economics, 104: Dewatripont, M. and Maskin, E. (1990), Contract Renegotiation in Models of Asymmetric Information, European Economic Review, 34(2-3): * Dewatripont, M. and Maskin, E. (1995), Credit and Efficiency in Centralized and Decentralized Economies, Review of Economic Studies 62(4), Diamond, D. (1989), Reputation Acquisition in Debt Markets, Journal of Political Economy, 97(4), Hart, O. and J. Tirole (1988), Contract Renegotiation and Coasian Dynamics, Review of Economic Studies, 55: Laffont, J.-J. and J. Tirole (1988), The Dynamics of Incentive Contracts, Econometrica, 56(5): Laffont, J.-J. and J. Tirole (1990), Adverse Selection and Renegotiation in Procurement, Review of Economic Studies, 57: * Townsend, R. (1982), Optimal Multiperiod Contracts and the Gain from Enduring Relationships under Private Information, Journal of Political Economy, 90,

6 7. Implementation, incomplete contracts and authority * Bolton, P. and M. Dewatripont (2005), Contract Theory, book chapter 11: Incomplete Contracts, and chapter 12: Foundations of contracting with unverifiable information. * Aghion, P., and P. Bolton (1992), "An 'Incomplete Contracts' Approach to Financial Contracting," Review of Economic Studies, 59: Aghion, P., M. Dewatripont and P. Rey. (1994). "Renegotiation Design with Unverifiable Information." Econometrica 62: * Aghion, P., M. Dewatripont and P. Rey (2002), On Partial Contracting, European Economic Review. * Aghion, P. and J. Tirole (1997), Formal and Real Authority in Organizations, Journal of Political Economy, 105(1), Che, Y. and D. Hausch. (1999). "Cooperative Investments and the Value of Contracting." American Economic Review 89: Dewatripont, M. (2001), Authority, Walras-Bowley Lecture presented at the 2001 North-American Meeting of the Econometric Society. * Grossman, S. and O. Hart (1986), "The Costs and Benefits of Ownership: A Theory of Vertical and Lateral Integration," Journal of Political Economy, 94(4): Hart, O. (1995). Firms, Contracts, and Financial Structure. Oxford University Press. Hart, O. and J. Moore. (1988). "Incomplete Contracts and Renegotiation." Econometrica 56: Hart, O. and J. Moore (1990), "Property Rights and the Nature of the Firm," Journal of Political Economy, 98 (6): * Hart, O. and J. Moore (1999), Foundations of Incomplete contracts," Review of Economic Studies, 66(1): Legros, P. and A. Newman (2002), Competing for Ownership, mimeo. * Maskin, E. (1999) Nash Equilibrium and Welfare Optimality," Review of Economic Studies, 66, Maskin, E. and J. Tirole (1999), Unforeseen Contingencies and Incomplete Contracts, Review of Economic Studies. Maskin, E. and J. Moore (1999), Implementation and Renegotiation," Review of Economic Studies. Moore, J. and R. Repullo (1988) Subgame Perfect Implementation, Econometrica, 56:

7 Noldeke, G. and K. M. Schmidt. (1995). "Option Contracts and Renegotiation: A Solution to the Hold-up Problem." Rand Journal of Economics, 26(2): Segal, I. (1999), Complexity and Renegotiation: A Foundation for Incomplete Contracts, Review of Economic Studies. * Tirole, J. (1999), Incomplete Contracts: Where Do We Stand? Econometrica, 67(4):