Issue 3

Volume 10 JOURNAL OF ECONOMICS & MANAGEMENT STRATEGY
Fall 2001

Implicit Contracts, Managerial Incentives, and Financial Structure

Roberta Dessí
This paper examines how managers may be given incentives to exert effort, and to implement efficient implicit contracts with workers. Under certain assumptions, this can be achieved by tying managerial compensation to shareholder value. However, if reputation effects are weak, it is more efficient to adopt an incentive scheme in which the manager is punished by outside investor intervention when performance falls below a critical level, and otherwise retains control, receiving a fixed reward. The required form of outside intervention can be implemented through a financial structure combining hard debt with a dispersed ownership structure.

On the Evolution of Overconfidence and Entrepreneurs

Antonio E. Bernardo and Ivo Welch
This paper explains why seemingly irrational overconfident behavior can persist. Information aggregation is poor in groups in which most individuals herd. By ignoring the herd, the actions of overconfident individuals (“entrepreneurs”) convey their private information. However, entrepreneurs make mistakes and thus die more frequently. The socially optimal proportion of entrepreneurs trades off the positive information externality against high attrition rates of entrepreneurs, and depends on the size of the group, on the degree of overconfidence, and on the accuracy of individuals' private information. The stationary distribution trades off the fitness of the group against the fitness of overconfident individuals.

Electricity Auctions

Thomas-Olivier Léautier
This article examines auctions in the electricity industry. We find that the laws of physics that rule power transmission networks defeat ex post productive efficiency: the cheapest combination of generating plants is not always selected, not even in the optimal auction. Furthermore, neither the pay-your-bid nor the uniform-price auction coincides in general with the optimal auction, nor do they yield productive efficiency. Our analysis also sheds light on behavior observed in existing power markets, and leads to policy recommendations. First, producers protected by transmission constraints must see their bids capped in the short run to curb their ability to extract large rents. Second, producers apparently hurt by the unavailability of transmission capacity may benefit from it. Hence, contrary to common wisdom, policy makers cannot rely on them to finance or advocate transmission expansion.

Trade Secrets and Information Sharing

Thomas Rønde
If trade secrets are weakly protected by law, firms risk losing their valuable information when employees are hired by competitors. It may therefore be optimal to limit the number of employees who share the trade secrets even if it reduces the firm's productive efficiency. The benefits of limited information sharing are greatest if the efficiency cost is low and the competition in the market is neither very tough nor very weak. It is shown that it is more profitable to reduce the information sharing by giving the employees different information than by giving some employees more information than others.

Second-Mover Advantages in Dynamic Quality Competition

Heidrun C. Hoppe and Ulrich Lehmann-Grube
This paper explores a dynamic model of product innovation, extending the work of Dutta, Lach, and Rustichini (1995). It is shown that if R&D costs for quality improvements are low, the dynamic competition is structured as a race for being the pioneer firm with payoff equalization in equilibrium, but switches to a waiting game with a second-mover advantage in equilibrium if R&D costs are high. Moreover, the second-mover advantage increases monotonically as R&D becomes more costly.

Endogenously Asynchronous Entries into an Uncertain Industry

Midori Hirokawa and Dan Sasaki
We model and analyze a priori symmetric duopoly where supply quantity adjustment is slow and time-consuming. The state of demand is ex ante uncertain, and becomes observable a certain time period after at least one firm's entry. We characterize those conditions under which sequential entries can be endogenously chosen either as an asymmetric pure-strategy equilibrium or as a consequence of a symmetric mixed-strategy equilibrium. Also, in the limit where information revelation is infinitely fast (i.e., the time period it requires becomes infinitesimally short), the expected waiting time until the first entry does not necessarily become proportionately short, whilst the time interval between the leader's entry and the follower's entry does become infinitesimally short. This suggests that chronologically nearly simultaneous entry should not necessarily be interpreted as counterevidence against leader-follower relations. In addition to equilibrium comparative statics, we also analyze some of the welfare issues associated with strategic timing of entry.