Subversive Conversations
with Archishman Chakraborty and Rick Harbaugh
R&R Journal of Political Economy
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.
Equilibrium Selection Through Forward Induction in Cheap Talk Games
with Nicola Persico
R&R Games and Economic Behavior
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.
Optimal Banking with Delegated Monitoring
with Tai-Wei Hu
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.
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.
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.
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.
Depreciation in Dynamic Contribution Games: A Folk Theorem
with Marco Battaglini
Abstract: The literature on contribution games, where players' level of participation (or their aggregate contribution) is assumed to be monotonic, concludes that efficient outcomes are typically not achievable. We show that these qualitative results are not robust when any non-zero depreciation of contributions is assumed: we prove a folk theorem in this setting and thus show efficient public good provision is possible. Inspired by public good provision, we generalize these games to allow for a more general payoff-relevant state. We show that in the more general environment our observations hold: with zero depreciation efficient outcomes are not achievable, but a folk theorem holds with any positive level of depreciation.
