Case Lounge

(Jerome Greene Hall, room 701)

An Empirical Examination of Business Outsourcing Transactions

Abstract:
Despite the widespread media focus on business outsourcing transactions, we only have a limited understanding of how firms actually select a contractual framework to govern these complex relationships. This article analyzes a sample of onshore and offshore outsourcing contracts to pursue the topic. I first conduct a positive examination of the key features in 60 outsourcing transactions and find that firms employ a diverse array of terms to mitigate agency and hold-up problems. This work then provides the foundation for a second empirical inquiry--analyzing why specific relationships take on their observed forms. Using the micro-analytical dataset to explore links between transactional context and governance structure, I find a greater use of hierarchical contracting for outsourcing contracts with a high degree of appropriability risk. This analysis therefore provides support for hypotheses derived from transaction cost theories of hybrid organizational structure.

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Case Lounge

(Jerome Greene Hall, room 701)

Consent and Exchange
(with Lucian Arye Bebchuk)

Abstract:
In some cases, the law permits a party that unilaterally provides a benefit to another party to recover the estimated value of this benefit. Despite calls for expanding the set of cases to which such a restitution rule applies, the law commonly applies a mutual consent rule under which a party providing another with a benefit cannot obtain any recovery without securing the advance consent of the beneficiary to the transaction. We provide an efficiency rationale for the undesirability of broad use of the restitution rule by identifying significant adverse ex ante effects of the rule that are avoided by the consent requirement. Even assuming that courts' errors in estimating buyer benefits would be unbiased, a restitution rule would strengthen sellers' hand by providing them with a put option that they may but do not have to use. As a result, the restitution rule would encourage inefficient market entry by low-quality sellers that would not contribute to any efficient transactions but would be able to extract payments from buyers seeking to avoid an exchange with them. Furthermore, the restitution rule would discourage efficient market entry by some or all potential buyers of a good or service. Beyond the restitution rule, we extend our analysis to show that similar adverse effects can also arise from other "pricing" rules that provide buyers or sellers with call or put options to force an exchange at a judicially-determined price.

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Case Lounge

(Jerome Greene Hall, room 701)

When is a Willful Breach "Willful"?
The Link Between
Definitions and Damages

Abstract:
The existing literature on willful breach has not been able to define what should count as "willful." I argue here that any definition we adopt has implications for just how high damages should be raised in those cases where a breach qualifies as willful. As a result, both of these issues -- the definition of "willful," and the measure of damages for willful breach -- need to be considered simultaneously.

Specifically, if a definition of "willful" excludes all breachers who behaved efficiently, then in theory we can raise the penalty on the remaining inefficient breachers to any arbitrarily high level ("throw the book at them"). But if, instead, a given definition of willful would catch even some efficient breachers in its net, the damages assessed against willful breachers should be more limited. In that case, damages for willful breach might still justifiably be raised, but they should be raised only to the level that is economically efficient. This second approach thus requires courts to be good at assessing the efficient level of damages, but does not require them to evaluate the efficiency of the breacher's behavior. By contrast, the first approach demands exactly the opposite skills: courts must be good at evaluating the efficiency of the breacher's behavior, but they do not need to be good at assessing the efficient level of damages.

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Case Lounge

(Jerome Greene Hall, room 701)

A Theory of Rule Development
(with Richard Holden)

Abstract:
This paper develops a model with endogenously coarse rules. A principal hires an agent to take an action. The principal knows the optimal state-contingent action, but cannot communicate it perfectly due to communication constraints. The principal can use previously realized states as examples to define rules of varying breadth. We analyze how rules are chosen under several assumptions about how rules can be amended. We explore the inefficiencies that arise and how they depend on the ability to refine rules, the principal's time horizon and patience, and other factors. Our model exhibits path dependence in that the  efficacy of rule development depends on the sequence of realizations of the state. We interpret this as providing a foundation for persistent performance differences between similar organizations and explore the role of different delegation structures in ameliorating the effects of bounded communication.

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4:10 p.m.

Case Lounge

(Jerome Greene Hall, room 701)

Andy Newman (Boston University)

Loopholes: Social Learning and the Evolution of Contract Form
(with Philippe Jehiel)

Abstract:
We present a simple model of the evolution of contracts/rules/organizations via "loopholes." We study a setting in which the contracting environment is not
common knowledge among principals and agents. The economy has a continuum of locations; at each location there is a sequence of principals, each of whom offers a contract to a single agent. Principals offer contracts that deter (at a cost) the behavior they deem to be most likely to harm them. An agent may discover actions that are privately beneficial but are likely to harm her principal, and will undertake them if they are not deterred by the contract (loopholes). Future principals get limited observations of the agents' behavior, and optimally adjust their own contracts that deter the behaviors they know about, possibly closing the loopholes. The problem is that a loophole-free contract deters all undesired behavior and therefore conveys little information about what actions are feasible. Future principals may then choose loophole-laden contracts. The result is cycling of both undesired behaviors and contracts types. Contracts grow in complexity until they become so costly and the undesired actions perceived as so unlikely that they are then replaced by a simple (loophole-laden) contract.

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Room 107

(Jerome Greene Hall)

Margaret Meyer (Nuffield College, Oxford)

Gaming and Strategic Ambiguity in Incentive Provision
(with Richard Holden and Florian Ederer)

Abstract:
A central tenet of economics is that people respond to incentives. While an appropriately crafted incentive scheme can achieve the second-best optimum in the presence of moral hazard, the principal must be very well informed about the environment (e.g. the agent's preferences and the production technology) in order to achieve this. Indeed it is often suggested that incentive schemes can be gamed by an agent with superior knowledge of the environment, and furthermore that lack of transparency about the nature of the incentive scheme can reduce gaming. We provide a formal theory of these phenomena. We show that random or ambiguous incentive schemes induce more balanced efforts from an agent who performs multiple tasks and who is better informed about the environment than the principal is. On the other hand, such random schemes impose more risk on the agent per unit of effort induced. By identifying settings in which random schemes are especially effective in inducing balanced efforts, we show that, if tasks are sufficiently complementary for the principal, random incentive schemes can dominate the best deterministic scheme.