The Economic Theory of Incentives Volume I

Edited by David Martimort Professor, Paris School of and Research Director, the Ecole des Hautes Etudes en Sciences Sociales (EHESS), France

THE INTERNATIONAL LIBRARY OF CRITICAL WRITINGS IN ECONOMICS

An Elgar Research Collection Cheltenham, UK • Northampton, MA,'USA Contents

Acknowledgements ix Introduction David Martimort xiii

PART I COLLECTIVE DECISION PROBLEMS UNDER ASYMMETRIC INFORMATION

A. Public Goods and the Free Riding Problem

1. Claude d’Aspremont and Louis-Andre Gerard-Varet (1979), ‘Incentives and Incomplete InformationJournal of Public Economics, 11 (1), February, 25—45 5 2. Jerry Green and Jean-Jacques Laffont (1977), ‘Characterization of Satisfactory Mechanisms for the Revelation of Preferences for Public Goods’, Econometrica, 45 (2), March, 427-38 26 3. Theodore Groves (1973), ‘Incentives in Teams’, Econometrica, 41 (4), July, 617-31 38 4. Jean-Jacques Laffont and (1979), ‘A Differential Approach to Expected Utility Maximizing Mechanisms’, in Jean-Jacques Laffont (ed.), Aggregation and Revelation of Preferences, Studies in Public Economics: Volume 2, Part IV, Chapter 16, Amsterdam, the Netherlands, New York, NY, USA and Oxford, UK: North-Holland Publishing Company, 289-308 53 5. Jean-Jacques Laffont and Eric Maskin (1980), ‘A Differential Approach to Dominant Strategy Mechanisms’, Econometrica, 48 (6), September, 1507-20 73 6. George J. Mailath and Andrew Postlewaite (1990), ‘Asymmetric Information Bargaining Problems with Many Agents’, Review of Economic Studies, 57 (3), July, 351-67 87

B. Incentive Compatibility and the Revelation Principle

7. Allan Gibbard (1973), ‘Manipulation of Voting Schemes: A General Result’, Econometrica, 41 (4), July, 587-601 107 8. Partha Dasgupta, Peter Hammond and Eric Maskin (1979), ‘The Implementation of Social Choice Rules: Some General Results on Incentive Compatibility’, Review of Economic Studies, 46 (2), April, 185-216 122 9. Roger B. Myerson (1979), ‘Incentive Compatibility and the Bargaining Problem’, Econometrica, 47 (1), January, 61-73 154 VI The Economic Theory of Incentives I

10. Roger B. Myerson (1982), ‘Optimal Coordination Mechanisms in Generalized Principal-Agent Problems’, Journal of Mathematical Economics, 10 (1), June, 67-81 167

C. Full Implementation

11. Joel S. Demski and David Sappington (1984), ‘Optimal Incentive Contracts with Multiple Agents’, Journal of Economic Theory, 33 (1), June 152-71 185 12. Eric Maskin (1999), ‘Nash Equilibrium and Welfare Optimality’, Review of Economic Studies, Special Issue: Contracts, 66 (1), January, 23-38 205 13. Eric Maskin and (1999), ‘Implementation and Renegotiation’, Review of Economic Studies, Special Issue: Contracts, 66 (1), January, 39-56 221 14. John Moore and Rafael Repullo (1988), ‘Subgame Perfect Implementation’, Econometrica, 56 (5), September, 1191-220 239 15. John Moore and Rafael Repullo (1990), ‘Nash Implementation: A Full Characterization’, Econometrica, 58 (5), September, 1083-99 269 16. Thomas R. Palfrey and Sanjay Srivastava (1989), ‘Implementation with Incomplete Information in Exchange Economies’, Econometrica, 57 (1), January, 115-34 286 17. Dilip Mookherjee and Stefan Reichelstein (1990), ‘Implementation via Augmented Revelation Mechanisms ’, Review of Economic Studies, 57 (3), July, 453-75 306

D. Interim Efficiency

18. Bengt Holmstrom and Roger B. Myerson (1983), ‘Efficient and Durable Decision Rules with Incomplete Information’, Econometrica, 51 (6), November, 1799-819 331 19. John O. Ledyard and Thomas R. Palfrey (1999), ‘A Characterization of Interim Efficiency with Public Goods’, Econometrica, 67 (2), March, 435-48 352

E. Auctions

20. Jacques Cremer and Richard P. McLean (1988), ‘Full Extraction of the Surplus in Bayesian and Dominant Strategy Auctions’, Econometrica, 56 (6), November, 1247-57 369 21. Philippe Jehiel and Benny Moldovanu (2001), ‘Efficient Design with Interdependent Valuations’, Econometrica, 69 (5), September, 1237-59 380 The Economic Theory of Incentives I vii

22. Eric Maski'n and John Riley (1989), ‘Optimal Multi-unit Auctions’, in (ed.), The Economics of Missing Markets, Information, and Games, Chapter 14, Oxford, UK: Clarendon Press, 312-35 403 23. Roger B. Myerson (1981), ‘Optimal Auction Design’, Mathematics of Operations Research, 6 (1), February, 58-73 427 24. John G. Riley and William F. Samuelson (1981), ‘Optimal Auctions’, American Economic Review, 71 (3), June, 381-92 443

F. Robust Mechanism Design

25. Dirk Bergemann and Stephen Morris (2005), ‘Robust Mechanism Design’, Econometrica, 73 (6), November, 1771-813 457 26. Philippe Jehiel, Moritz Meyer-ter-Vehn, Benny Moldovanu and William R. Zame (2006), ‘The Limits of Ex Post Implementation’, Econometrica, 74 (3), May, 585-610 500 27. Dilip Mookherjee and Stefan Reichelstein (1992), ‘Dominant Strategy Implementation of Bayesian Incentive Compatible Allocation Rules’, Journal of Economic Theory, 56 (2), April, 378-99 526 28. Zvika Neeman (2004), ‘The Relevance of Private Information in Mechanism Design’, Journal of Economic Theory, 117 (1), July, 55-77 548 29. Robert Wilson (1987), ‘Game-Theoretic Analyses of Trading Processes’, in Truman F. Bewley (ed.), Advances in Economic Theory: Fifth World Congress, Chapter 2, Cambridge, UK, New York, NY, USA and Melbourne, Australia: Cambridge University Press, 33-70 571

G. The Coase Theorem under Asymmetric Information: Scope and Value

30. Roger B. Myerson and Mark A. Satterthwaite (1983), ‘Efficient Mechanisms for Bilateral Trading’, Journal of Economic Theory, 29 (2), April, 265-81 611 31. Peter Cramton, Robert Gibbons and Paul Klemperer (1987), ‘Dissolving a Partnership Efficiently’, Econometrica, 55 (3), May, 615-32, Erratum 628 32. Steven R. Williams (1999), ‘A Characterization of Efficient, Bayesian Incentive Compatible Mechanisms’, Economic Theory, 14 (1), July, 155-80 647 viii The Economic Theory of Incentives I

PART II COLLECTIVE DECISION PROBLEMS UNDER MORAL HAZARD

A. Moral Hazard in Teams

33. Bengt Holmstrom (1982), ‘Moral Hazard in Teams’, Bell Journal of Economics, 13 (2), Autumn, 324-40 677 34. Patrick Legros and Steven A. Matthews (1993), ‘Efficient and Nearly-Efficient Partnerships’, Review of Economic Studies, 68 (3), July, 599-611 694 35. Eric Rasmusen (1987), ‘Moral Hazard in Risk-Averse Teams’, RAND Journal of Economics, 18 (3), Autumn, 428-35 707 36. David Rahman (2012), ‘But Who Will Monitor the Monitor?’, American Economic Review, 102 (6), October, 2767-97 715

B. The Firm as a Hierarchy: Relative or Joint Performance Evaluations?

37. Yeon-Koo Che and Seung-Weon Yoo (2001), ‘Optimal Incentives for Teams’, American Economic Review, 91 (3), June, 525—41 749 38. Edward P. Lazear and Sherwin Rosen (1981), ‘Rank-Order Tournaments as Optimum Labor Contracts’, Journal of Political Economy, 89 (5), October, 841-64 766 39. Hideshi Itoh (1991), ‘Incentives to Help in Multi-Agent Situations’, Econometrica, 59 (3), May, 611-36 790 40. Dilip Mookherjee (1.984), ‘Optimal Incentive Schemes with Many Agents’, Review of Economic Studies, LI (3), July, 433^16 816 41. Barry J. Nalebuff and Joseph E. Stiglitz (1983), ‘Prizes and Incentives: Towards a General Theory of Compensation and Competition’, Bell Journal of Economics, 14 (1), Spring, 21-43 830 42. Ching-To Ma (1988), ‘Unique Implementation of Incentive Contracts with Many Agents’, Review of Economic Studies, LV (4), October, 555-71 853 The Economic Theory of Incentives Volume II

Edited by David Martimort Professor, Paris School of Economics and Research Director, the Ecole des Hautes Etudes en Sciences Sociales (EHESS), France

THE INTERNATIONAL LIBRARY OF CRITICAL WRITINGS IN ECONOMICS

An Elgar Research Collection Cheltenham, UK • Northampton, MA, USA Contents

Acknowledgements ix Introduction An introduction to both volumes by the editor appears in Volume I

PART I COLLECTIVE DECISION PROBLEMS: INCOMPLETE CONTRACTING AND THE NON-VERIFIABILITY PARADIGM

A. Property Rights, Authority and Capital Structure

1. and Patrick Bolton (1992), ‘An Incomplete Contracts Approach to Financial Contracting’, Review of Economic Studies, 59 (3), July, 473-94 5 2. Philippe Aghion and (1997), ‘Formal and Real Authority in Organizations’, Journal of Political Economy, 105 (1), February, 1-29 27 3. Aaron S. Edlin and Stefan Reichelstein (1996), ‘Holdups, Standard Breach Remedies, and Optimal Investment’, American Economic Review, 86 (3), June, 478-501 56 4. and Jean Tirole (1994), ‘A Theory of Debt and Equity: Diversity of Securities and Manager-Shareholder Congruence’, Quarterly Journal of Economics, 109 (4), November, 1027-54 80 5. Sanford J. Grossman and Oliver D. Hart (1986), ‘The Costs and Benefits of Ownership: A Theory of Vertical and Lateral Integration’, Journal of Political Economy, 94 (4), August, 691—719 108 6. and John Moore (1990), ‘Property Rights and the Nature of the Firm’, Journal of Political Economy, 98 (6), December, 1119-58 137 7. Jean Tirole (1986), ‘Procurement and Renegotiation’, Journal of Political Economy, 94 (2), April, 235-59 177

B. The Foundations of Incomplete Contracts

8. Ilya Segal (1999), ‘Complexity and Renegotiation: A Foundation for Incomplete Contracts’, Review of Economic Studies, Special Issue: Contracts, 66 (1), January, 57-82 205 9. Eric Maskin and Jean Tirole (1999), ‘Unforeseen Contingencies and Incomplete Contracts’, Review of Economic Studies, Special Issue: Contracts, 66 (1), January, 83-114 231 VI The Economic Theory of Incentives II

C. Relational Contracts and Subjective Evaluations

10. Jonathan Levin (2003), ‘Relational Incentive Contracts’, American Economic Review, 93 (3), June, 835-57 265 11. W. Bentley MacLeod and James M. Malcomson (1989), ‘Implicit Contracts, Incentive Compatibility, and Involuntary Unemployment’, Econometrica, 57 (2), March, 447-80 288 12. W. Bentley MacLeod (2003), ‘Optimal Contracting with Subjective Evaluation’, American Economic Review, 93 (1), March, 216-40 322

PART II COLLECTIVE DECISION PROBLEMS: THE MULTI- CONTRACTING ORGANIZATION

A. Collusion: When Agents Share Information and Coordinate Actions

13. Hideshi Itoh (1993), ‘Coalitions, Incentives, and Risk Sharing’, Journal of Economic Theory, 60 (2), August, 410-27 351 14. Jean-Jacques LafFont and David Martimort (1999), ‘Separation of Regulators Against Collusive Behavior’, RAND Journal of Economics, 30 (2), Summer, 232-62 369 15. Jean-Jacques LafFont and Jean Tirole (1991), ‘The Politics of Government Decision-Making: A Theory of Regulatory Capture’, Quarterly Journal of Economics, 106 (4), November, 1089-127 400 16. Jean Tirole (1986), ‘Hierarchies and Bureaucracies: On the Role of Collusion in Organizations’, Journal of Law, Economics, and Organization, 2 (2), Fall, 181-214 439 17. Hal R. Varian (1990), ‘Monitoring Agents With Other Agents’, Journal of Institutional and Theoretical Economics, 146 (1), March, 153-74 473

B. Collusion with Asymmetric and Soft Information

18. Yeon-Koo Che and Jinwoo Kim (2006), ‘Robustly Collusion-Proof Implementation’, Econometrica, 74 (4), July, 1063-107 497 19. Jean-Jacques LafFont and David Martimort (1997), ‘ Collusion under Asymmetric Information’, Econometrica, 65 (4), July, 875-911 542

C. Hierarchies and Decentralization

20. Sandeep Baliga and Tomas Sjostrom (1998), ‘Decentralization and Collusion’, Journal of Economic Theory, 83 (2), December, 196-232 581 21. David P. Baron and David Besanko (1992), ‘ Information, Control, and Organizational Structure’, Journal of Economics and Management Strategy, 1 (2), Summer, 237-75 618 The Economic Theory of Incentives II vii

22. Jean-Jacques Laffbnt and David Martimort (1998), ‘Collusion and Delegation’, RAND Journal of Economics, 29 (2), Summer, 280-305 657 23. Nahum D. Melumad, Dilip Mookherjee and Stefan Reichelstein (1995), ‘Hierarchical Decentralization of Incentive Contracts’, RAND Journal of Economics: Symposium on the Economics of Organization, 26 (4), Winter, 654-72 683 24. Dilip Mookherjee and Masatoshi Tsumagari (2004), ‘The Organization of Supplier Networks: Effects of Delegation and Intermediation’, Econometrica, 72 (4), July, 1179-219 702

D. Multilateral Contracting and Common Agency

25. B. Douglas Bemheim and Michael D. Whinston (1986), ‘Menu Auctions, Resource Allocation, and Economic Influence’, Quarterly Journal of Economics, Cl (1), February, 1-31 745 26. B. Douglas Bemheim and Michael D. Whinston (1986), ‘Common Agency’, Econometrica, 54 (4), July, 923-42 776 27. David Martimort and Lars Stole (2002), ‘The Revelation and Delegation Principles in Common Agency Games’, Econometrica, 70 (4), July, 1659-73 , 796 .28. David Martimort and Lars Stole (2009), ‘Market Participation in Delegated and Intrinsic Common-Agency Games’, RAND Journal of Economics, 40 (1), Spring, 78-102 811 29. Ilya Segal (1999), ‘Contracting with Externalities’, Quarterly Journal of Economics, CXIV (2), May, 337-88 ' 836

E. Endogenous Common Agency

30. B. Douglas Bemheim and Michael D. Whinston (1998), ‘Exclusive Dealing’, Journal of Political Economy, 106 (1), February, 64-103 891 31. David Martimort (1996), ‘ Exclusive Dealing, Common Agency, and Multiprincipals Incentive Theory’, RAND Journal of Economics, 27 (1), Spring, 1-31 931 The Economic Theory of Incentives II vii

22. Jean-Jacques Laffont and David Martimort (1998), ‘Collusion and Delegation’, RAND Journal of Economics, 29 (2), Summer, 280-305 657 23. Nahum D. Melumad, Dilip Mookherjee and Stefan Reichelstein (1995), ‘Hierarchical Decentralization of Incentive Contracts’, RAND Journal of Economics: Symposium on the Economics of Organization, 26 (4), Winter, 654-72 683 24. Dilip Mookherjee and Masatoshi Tsumagari (2004), ‘The Organization of Supplier Networks: Effects of Delegation and Intermediation’, Econometrica, 72 (4), July, 1179-219 702

D. Multilateral Contracting and Common Agency

25. B. Douglas Bemheim and Michael D. Whinston (1986), ‘Menu Auctions, Resource Allocation, and Economic Influence’, Quarterly Journal of Economics, Cl (1), February, 1-31 745 26. B. Douglas Bemheim and Michael D. Whinston (1986), ‘Common Agency’, Econometrica, 54 (4), July, 923-42 776 27. David Martimort and Lars Stole (2002), ‘The Revelation and Delegation Principles in Common Agency Games’, Econometrica, 70 (4), July, 1659-73 796 .28. David Martimort and Lars Stole (2009), ‘Market Participation in Delegated and Intrinsic Common-Agency Games’, RAND Journal of Economics, 40 (1), Spring, 78-102 811 29. Ilya Segal (1999), ‘Contracting with Externalities’, Quarterly Journal of Economics, CXIV (2), May, 337-88 836

E. Endogenous Common Agency

30. B. Douglas Bemheim and Michael D. Whinston (1998), ‘Exclusive Dealing’, Journal of Political Economy, 106 (1), February, 64-103 891 31. David Martimort (1996), ‘Exclusive Dealing, Common Agency, and Multiprincipals Incentive Theory’, RAND Journal of Economics, 27 (1), Spring, 1-31 931