CONTRACT THEORY - I

2nd Module, 2002-2003

TA: Aleksey Makrushin, AMakrushin@cefir.ru

This course is the first one in a series of two half-semester courses in contract theory taught at NES in the 2002-2003 academic year. The two courses are to cover recent developments in economics of information and organization. Contract Theory I discusses in detail adverse selection and moral hazard models, including moral hazard in teams, multi-tasking and dynamic settings. Contract Theory I also briefly introduces the incomplete contract theory, and then covers application of complete and incomplete contract theory to corporate governance and financial contracting. Contract Theory II provides an in-depth coverage of incomplete contract theory and the property rights theory. The second part of Contract Theory II discusses mechanism design and auction theory. The third part of Contract Theory II applies the contract theory to economics of organization. There are no prerequisites for Contract Theory I except the basic course of Microeconomic Theory. 

There will be three problem sets and a final exam and a final exam. The problem sets will contribute 30% to the course grade.

General references

There is no comprehensive contract theory textbook.

1.    Salanie. The Economics of Contracts: A Primer. MIT Press 1997.

2.    Hart and Holmstrom.  The Theory of Contracts.  In Advances in Economic Theory, Fifth World Congress, ed. by Truman Bewley. Cambridge University Press, 1987.

3.    Mas-Colell, Whinston and Green. The Microeconomic Theory. Chapters 13,14.

4.    Hart. Firms, Contracts and Financial Structure. Oxford University Press, 1995.

Syllabus

1-3. Adverse selection: screening. Second degree price discrimination. Applications to credit rationing.

·         1, ch.3

·         3, ch. 13-14

4.  Signalling. Equilibrium refinements. Applications to education and labor market.

·       1, ch.4

·       3, ch. 13-14

5-6.  Moral hazard. Sufficient statistic. Insurance vs incentives. Models with liquidity constraints. Limitations of the first order approach.

·       1, ch. 5

·       2

·       3, ch. 14

7-8.  Linearity and aggregation. Multitasking. Moral hazard in teams.

·       B.Holmstrom and P.Milgrom (1991) "Aggregation and Linearity in the Provision of Intertemporal Incentives" Econometrica, March 1987.

·       B.Holmstrom and P.Milgrom (1991) Multitask principal-agent analysis: Incentive contracts, asset ownership and job design. Journal of Law, Economics and Organization 7: 24-51.

·       B.Holmstrom (1982) Moral hazard in teams. Bell Journal of Economics, Autumn 1982.

10-11.  Dynamics of complete contracts. Dynamic adverse selection. Repeated moral hazard. Ratchet effect. Career concerns. Commitment and renegotiation.

·         1, ch. 6

·         B. Holmstrom (1999) Managerial Incentive Problems: A Dynamic Perspective. Review of Economic Studies, 66 (1): 169-182

·         M.Dewatripont, I.Jewitt, J.Tirole (1999) “The Economics of Career Concerns: Part I: Comparing Information Structures” Review of Economic Studies, 66 (1): 183-198

12.  Incomplete contracts.  

·       4, ch. 2-3

·       J.Tirole (1999) Incomplete contracts: Where Do We Stand? Econometrica 67(4): 741-781.

·       1, ch. 7

13-14.  Financial contracting and corporate governance. 

·         J.Tirole (2001) “Corporate Governance” Econometrica 69(1): 1-35.

·         6, ch.5-7

·         O. Hart (2001). Financial Contracting. Journal of Economic Literature. 39(4), 1079-1101

·         S.Myers and N.Majluf (1984) Corporate financing and investment decisions when firms have information that investors do not have. Journal of Financial Economics 13: 187-221.

·         M.Dewatripont and J.Tirole (1994) A theory of debt and equity: diversity of securities and manager-shareholder congruence. Quarterly Journal of Economics 109(4): 1027-1054.

·       E.Berglof and E.L.von Thadden (1994) Short-term versus long-term interests: capital structure with multiple investors Quarterly Journal of Economics 109(4): 1055-1084.