Joanna Tyrowicz Empirics of contract theory Institutional Economics.
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Transcript of Joanna Tyrowicz Empirics of contract theory Institutional Economics.
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“But I thought you were going to talk about econometrics?!”
Alice said, “Would you please tell me which way to go from here?” The cat said, “That depends on where you want to get to.”
Lewis Carroll Your choice of econometric models depends on
The question you want to ask The data you have to answer the question The way you use the data to answer the question
We will talk about these three things and how they relate to different models.
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What Are The Kinds of Research Questions?
What are the differences between governance structures?
What are the differences (and interdependencies) within
governance structures?
What factors affect choice of governance structures?
What are the implications of governance choice?
For performance within the transaction
For performance of other mechanisms, markets, etc.
How/Why do governance structures evolve? proliferate?
How does the institutional environment (political, legal,
social, market forces) affect the answers to these questions?
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A Framework for Analyzing (Contract) Structures
Three Fundamental Elements of Transactions Allocation of value
What is the nature of value? How is price determined? Allocation of uncertainty
Product uncertainty Market uncertainty Party/behavioral uncertainty
Allocation of decision rights Decision rights over (physical/financial) asset use Decision rights over human assets/behavior Decision rights over product design, creation, delivery
In what ways does any one affect the other three?
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A Framework for Analyzing (Contract) Structures
Fundamentals of Economic Organization (Brickley, Smith & Zimmerman) Structure of Decision Rights
Who positioned to make the “best” decisions (based on information availability, measurement costs, incentive scheme)?
Incentive System How to reward “good” decision making (and punish bad)? What is the value of a “good” decision?
Performance measures How can you tell if decisions are good or bad? What is the relevance of decision making to value creation?
Again, these are interdependent
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A Framework for Analyzing (Contract) Structures
Basic Contract Structure
•Operative terms of agreement
•Mechanics of the terms
•Representations & warranties
•Covenants
•Positive
•Negative
•Conditions
•Termination
•Miscellaneous other terms
Exchange of property rights and terms of value (allocation of property, value, uncertainty)
Information disclosure (adverse selection)
‘Unilateral’ promises of behavior (do’s & don’ts) related to moral hazard potentialSet criteria and define decision rights to continue or terminate the deal
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Problem 1: Definitions
It is impossible to measure what you can’t define: What is vertical integration?
Asset ownership? If so, what is ownership? Hierarchical control? If so, what about ownership?
What is asset specificity? Specific relative to what? The transaction? The
trading parties? The local market? The industry? If the motivation for opportunism is the quasi-rent, is
there a quasi-rent? What is its source? Size? What do we mean by “optimal governance structure”?
If economic efficiency, how do we evaluate governance performance? Can we isolate the role of governance?
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Problem 2: Where Do I Get the Data?
There are large (commercial) datasets with information on various types of contracts: ExecuComp (CompuStat)- executive compensation SDC Platinum (Thompson Financial) – various
financing, IPO, mergers and acquisitions, and joint venture agreements
Collect your own: Collect from firms or government agencies that
oversee businesses Surveys of decision makers
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Pro’s and Con’s
Large data sets containing data in specific terms of
contracts
Good: Large samples make statistical analysis and
generalization more robust
Good: Relatively low transaction costs of getting data
Bad: Relatively high price of data
Bad: Limited information about the actual structure of
the contract, so you cannot control for other
differences in terms that may be important
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Pro’s and Con’s Primary Data Collection
Good: can collect the specific contract/transaction data in which you are most interested in a way that fits your hypothesis and model
Good: can examine relationship of different terms (Anderson, 1999)
Good: can combine surveys, contract forms, etc.
Bad: Relatively high collection costs
Bad: As a result, samples are typically small, which raises statistical problems
Bad: Case studies and surveys are suspect
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Pro’s and Con’s Case Studies – observations from a single firm/industry
Good: tremendously rich detail on terms and management of contracts
Bad: may be difficult to gain (honest) cooperation
Bad: possibly limited statistical application
Bad: limited generalizable information
Bad: profession views them with suspicion
Good: tremendously rich detail on terms and management of contracts that cannot be replicated in other ways
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If data are so hard to get, where did existing studies come from?
Many „make or buy” studies have no primary data related to the actual transactions.
Use industry/firm census data and secondary data sources that describe integration and market behavior
Hypothesize relations at a firm level and test (e.g. study of vertical integration in petrochemicals on the website)
Many studies
use the large data sets and
look at specific contract terms and
discount (or ignore) the interaction of omitted contract terms
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If data are so hard to get, where did existing studies come from?
Many contracts are filed with regulatory agencies, which may be available for research: Federal Trade Commission/State: franchise agreements State departments of health: first contact physician
contracts Maritime Commission: container shipping contracts Federal Energy Regulatory Commission/State: utility
contracts Securities & Exchange Commission: corporate contracts
Executive compensation, financial, M&A, major transactions
“Sunshine laws”/FOIA: government procurements & concessions
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If data are so hard to get, where did existing studies come from?
It’s Not What You Know, But Who You Know Many of the best papers on contracts are a result of
personal connections to people in places with access to contracts (e.g., Mayer & Silverman, Mayer & Nickerson, Heuth & Ligon; Crocker & Reynolds)
Luck Many good papers on contract structure and
performance were cases of being in the right place at the right time (e.g., Crocker & Masten studies of natural gas, Knoeber studies on poultry contracts, Dubois on land use)
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A Central Repository of Contracts
The Contracting and Organizations Research Institute (CORI) is undertaking to create a collection of contracts and data on organizational forms as a resource for researchers. Over 30,000 contracts from SEC filings Over 5,000 contracts from other sources
2500+ Telecommunication interconnection agreements
500+ first contact physician contracts 100+ teachers’ contracts University contracts
http://www.cori.missouri.edu
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Problem 3: I have it; now what do I do with it?
Statistical models depend on the question: Probit (to be or not to be?)
Ordered Probit: we have multiple, ordinal outcomes Logit/Tobit (how much to be?)
Multinomial Logit: we have multiple, non-ordinal outcomes
Conditional Logit: our data represent a panel Poisson (how many to be?) OLS Latent variable models: covariance based structural
equation models Production possibility frontier estimates=> Masten and Saussier paper on the web
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Additional problems and pitfalls: Equilibrium perspective
Studies of contract choice assume the observed choice is optimal Doesn’t permit “bad” choices Doesn’t capture dynamic/disequilibrium adjustment
Doesn’t test the actual performance of governance choice
Survivorship and self-selection biases are rampant This is the realm of endogeneity Censored data issues
Use of panel data (cross-sectional/times series) Fixed effects models to isolate firm-specific traits (+/-)
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Additional problems and pitfalls: Event study/hazard models
Look for “natural experiments”
Innovation/Rate of Adoption models
Multiple stage regressions (2SLS, 3SLS) Instrumental variables, SURE models
Structural switching models Iterative models
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So what do we do about it?
Empirical method is pointless if you don’t have an interesting question
Be clear in understanding and defining the economic significance of theoretical variables and empirical variables
Look for “Natural Experiments” (≈ changes or differences in institutions) to discriminate theories/control endogeneity
Econometric methods getting more complex.
Data are costly to collect, difficult to code, but worth it!
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Experience from doing contract empirics
Large literature on the theory of contracts: developed P-A models under asymmetric information
Much less empirical tests and estimations: for example adverse selection phenomenon well known theoretically but still not large number of empirical applications
Focus on ideas for structural estimation methods
Principal-Agent models (asymmetric information: moral hazard, adverse selection)
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Experience from doing contract empirics
Reduced form versus structural econometrics: Reduced form tests
Test theoretical predictions: a lot of empirical tests Tests of the presence of asymmetric information Adverse selection versus moral hazard: reverse
causality
Structural estimation methods: Theoretical model in terms of observables Identification questions
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The Logic of Modeling
Problems: In time agents learn (asymmetric information) ->
difficult to capture Two approaches:
Take contracts as given Assume contracts are optimal
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The Two Approaches Take observed contractual terms and make no assumptions
on optimality: Paarsch and Shearer (2000, 2004) - tree-planting labour
contracts data. Dubois and Vukina (2004) - animal production contracts
data. Abbring, Chiappori, Heckman, and Pinquet (2003) - car
insurance data.
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The Two Approaches Assume contracts are optimal and test implications of theory
on observables: Allen and Lueck (1992) examine the determinants of
contract choice (unimportance of risk). Ackerberg and Botticini (2002) if one controls for
endogenous matching between P and A, the A’s risk aversion significantly influence the contract choice.
Dubois (2002): risk sharing, incentives and land maintenance.
Wolak (1994): asymmetric information reduces output (boosts prices)
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Wolak 1994 The case of public utility (water supply) in California
Carefully studied conditions Theoretical model designed to match it Empirical testing of the model:
Not to check if the theory holds To see what’s the impact of comparable options
Principal selling a good in quantity q to an Agent whose tastes are indexed by θ
Cross sectional data, one principal and several agents Utility functions with (t is the price, α,β are known
parameters): The Principal does not know θ but has belief F Econometrician: observes only realized q, t (but a large
number of qi, ti ..) and not necessarily the contract t (q)
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Dubois and Vukina 2004 Contracts to vertically coordinate the production and
marketing of agricultural commodities common practice in many agricultural sectors.
The majority of agricultural contracts use high powered incentives.
In many production contracts in agriculture, all agents contracting with the same principal operate under apparently identical contract provisions.
Study the contract design problem and present the method that allows identification and estimation of structural parameters of the moral hazard model.
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Dubois and Vukina 2004 Identify the heterogeneity among agents (they have
different risk aversion attitudes and their preferences are observed by the principal).
Test predictions aimed at assessing the empirical reliability of the model.
Use panel data containing individual settlements of production contracts between
a company and independent farmers.
Explain an apparent anomaly frequently observed in many agricultural contracts principals use seemingly uniform contracts for the
purposes of governing the relationships with heterogeneous agents
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Dubois 2001 A different approach to moral hazard – threat of overuse. Use data on a developing country (Philippines) Modelling:
Current production affects future fertility If contracts long-term, optimal scheme would be assured by
using high powered incentives BUT contracts short-term Contracts incomplete, ‘cause cannot be contingent on land
fertility Principals less risk-averse than Agents (again: carefully
designed framework). Trade-off between production incentives, fertility incentives
and sharing of production risk: High powered incentives allow to share production risk Impossibility to commit to long-term contracts does not
allow to incorporate fertility incentives into the contract. Main conclusion area: land reform!
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Summary Econometric methods getting more complex = more fitted to
conditions
“The binding constraint is not technique, but data availability.”
Masten & Saussier, 2002
Directions for future fun : Endogenous delegation Endogenous matching Moral hazard and adverse selection Multiprincipal and mutiagent models Dynamics