1. A mechanism-design approach to property rights
Piotr Dworczak? Ellen Muir
(Northwestern; GRAPE) (Harvard)
October 18, 2023
Microeconomics Seminar, Boston College
?
Co-funded by the European Union (ERC, IMD-101040122). Views and opinions expressed are those of the authors
only and do not necessarily reflect those of the European Union or the European Research Council.
2. Motivation
• Assignment of property rights matters, particularly in the
presence of transaction costs (Coase, 1960; Williamson, 1979).
3. Motivation
• Assignment of property rights matters, particularly in the
presence of transaction costs (Coase, 1960; Williamson, 1979).
• There are tradeoffs in the design of property rights:
4. Motivation
• Assignment of property rights matters, particularly in the
presence of transaction costs (Coase, 1960; Williamson, 1979).
• There are tradeoffs in the design of property rights:
• Investment incentives;
5. Motivation
• Assignment of property rights matters, particularly in the
presence of transaction costs (Coase, 1960; Williamson, 1979).
• There are tradeoffs in the design of property rights:
• Investment incentives;
• Efficiency of reallocation;
6. Motivation
• Assignment of property rights matters, particularly in the
presence of transaction costs (Coase, 1960; Williamson, 1979).
• There are tradeoffs in the design of property rights:
• Investment incentives;
• Efficiency of reallocation;
• Market power and distribution of surplus.
7. Motivation
• Assignment of property rights matters, particularly in the
presence of transaction costs (Coase, 1960; Williamson, 1979).
• There are tradeoffs in the design of property rights:
• Investment incentives;
• Efficiency of reallocation;
• Market power and distribution of surplus.
• Example: How to optimally design spectrum licenses?
8. Key feature of our framework
• Our paper: Property rights determine the holder’s outside
options (with regard to the underlying good) in interactions:
9. Key feature of our framework
• Our paper: Property rights determine the holder’s outside
options (with regard to the underlying good) in interactions:
• Full property right: Holder can always keep the good;
10. Key feature of our framework
• Our paper: Property rights determine the holder’s outside
options (with regard to the underlying good) in interactions:
• Full property right: Holder can always keep the good;
• No rights: Outside option is (normalized to) zero;
11. Key feature of our framework
• Our paper: Property rights determine the holder’s outside
options (with regard to the underlying good) in interactions:
• Full property right: Holder can always keep the good;
• No rights: Outside option is (normalized to) zero;
• Renewable lease: Holder can keep the good at a price;
12. Key feature of our framework
• Our paper: Property rights determine the holder’s outside
options (with regard to the underlying good) in interactions:
• Full property right: Holder can always keep the good;
• No rights: Outside option is (normalized to) zero;
• Renewable lease: Holder can keep the good at a price;
• ...
13. Key feature of our framework
• Our paper: Property rights determine the holder’s outside
options (with regard to the underlying good) in interactions:
• Full property right: Holder can always keep the good;
• No rights: Outside option is (normalized to) zero;
• Renewable lease: Holder can keep the good at a price;
• ...
14. Key feature of our framework
• Our paper: Property rights determine the holder’s outside
options (with regard to the underlying good) in interactions:
• Full property right: Holder can always keep the good;
• No rights: Outside option is (normalized to) zero;
• Renewable lease: Holder can keep the good at a price;
• ...
• We propose a framework in which we characterize the optimal
property right using a mechanism-design approach.
34. To summarize
• Fundamental friction: Social planner cannot commit to future
trading mechanisms, resulting in
35. To summarize
• Fundamental friction: Social planner cannot commit to future
trading mechanisms, resulting in
• ex-post inefficiency (mechanism may be suboptimal);
36. To summarize
• Fundamental friction: Social planner cannot commit to future
trading mechanisms, resulting in
• ex-post inefficiency (mechanism may be suboptimal);
• hold-up problem (inefficient investment decisions).
37. To summarize
• Fundamental friction: Social planner cannot commit to future
trading mechanisms, resulting in
• ex-post inefficiency (mechanism may be suboptimal);
• hold-up problem (inefficient investment decisions).
• Planner chooses property rights to alleviate these frictions.
38. To summarize
• Fundamental friction: Social planner cannot commit to future
trading mechanisms, resulting in
• ex-post inefficiency (mechanism may be suboptimal);
• hold-up problem (inefficient investment decisions).
• Planner chooses property rights to alleviate these frictions.
• Question: What is the optimal set of rights?
39. To summarize
• Fundamental friction: Social planner cannot commit to future
trading mechanisms, resulting in
• ex-post inefficiency (mechanism may be suboptimal);
• hold-up problem (inefficient investment decisions).
• Planner chooses property rights to alleviate these frictions.
• Question: What is the optimal set of rights?
• Main result: The optimal property right is simple but flexible,
often featuring an option to own.
40. Property rights in economics
• Assignment of property rights matters, particularly in the
presence of transaction costs (Coase, 1960; Williamson, 1979).
41. Property rights in economics
• Assignment of property rights matters, particularly in the
presence of transaction costs (Coase, 1960; Williamson, 1979).
• Two large literatures:
42. Property rights in economics
• Assignment of property rights matters, particularly in the
presence of transaction costs (Coase, 1960; Williamson, 1979).
• Two large literatures:
• Property rights affect efficiency under private information:
43. Property rights in economics
• Assignment of property rights matters, particularly in the
presence of transaction costs (Coase, 1960; Williamson, 1979).
• Two large literatures:
• Property rights affect efficiency under private information:
• Myerson and Satterthwaite (1983);
44. Property rights in economics
• Assignment of property rights matters, particularly in the
presence of transaction costs (Coase, 1960; Williamson, 1979).
• Two large literatures:
• Property rights affect efficiency under private information:
• Myerson and Satterthwaite (1983);
• Cramton, Gibbons and Klemperer (1987), ...
45. Property rights in economics
• Assignment of property rights matters, particularly in the
presence of transaction costs (Coase, 1960; Williamson, 1979).
• Two large literatures:
• Property rights affect efficiency under private information:
• Myerson and Satterthwaite (1983);
• Cramton, Gibbons and Klemperer (1987), ...
• Property rights affect investment incentives:
46. Property rights in economics
• Assignment of property rights matters, particularly in the
presence of transaction costs (Coase, 1960; Williamson, 1979).
• Two large literatures:
• Property rights affect efficiency under private information:
• Myerson and Satterthwaite (1983);
• Cramton, Gibbons and Klemperer (1987), ...
• Property rights affect investment incentives:
• Grossman and Hart (1986), Hart and Moore (1990), Aghion,
Dewatripont and Rey (1994), Maskin and Tirole (1999a), ...
47. Marginal contribution
• We study both effects in a setting with one-sided private
information and exogenous distribution of bargaining power.
48. Marginal contribution
• We study both effects in a setting with one-sided private
information and exogenous distribution of bargaining power.
• To the best of our knowledge, our paper is first to characterize
the optimal property right from a non-parametric class
(in a setting where the first best cannot in general be achieved).
49. Marginal contribution
• We study both effects in a setting with one-sided private
information and exogenous distribution of bargaining power.
• To the best of our knowledge, our paper is first to characterize
the optimal property right from a non-parametric class
(in a setting where the first best cannot in general be achieved).
• Attractive properties of option-to-own contracts were studied:
50. Marginal contribution
• We study both effects in a setting with one-sided private
information and exogenous distribution of bargaining power.
• To the best of our knowledge, our paper is first to characterize
the optimal property right from a non-parametric class
(in a setting where the first best cannot in general be achieved).
• Attractive properties of option-to-own contracts were studied:
• Liability rules raise second-best efficiency in bargaining.
51. Marginal contribution
• We study both effects in a setting with one-sided private
information and exogenous distribution of bargaining power.
• To the best of our knowledge, our paper is first to characterize
the optimal property right from a non-parametric class
(in a setting where the first best cannot in general be achieved).
• Attractive properties of option-to-own contracts were studied:
• Liability rules raise second-best efficiency in bargaining.
- Che (2006), Segal and Whinston (2016)
52. Marginal contribution
• We study both effects in a setting with one-sided private
information and exogenous distribution of bargaining power.
• To the best of our knowledge, our paper is first to characterize
the optimal property right from a non-parametric class
(in a setting where the first best cannot in general be achieved).
• Attractive properties of option-to-own contracts were studied:
• Liability rules raise second-best efficiency in bargaining.
- Che (2006), Segal and Whinston (2016)
• Options to own/ put options may induce efficient
investments in hold-up problems.
53. Marginal contribution
• We study both effects in a setting with one-sided private
information and exogenous distribution of bargaining power.
• To the best of our knowledge, our paper is first to characterize
the optimal property right from a non-parametric class
(in a setting where the first best cannot in general be achieved).
• Attractive properties of option-to-own contracts were studied:
• Liability rules raise second-best efficiency in bargaining.
- Che (2006), Segal and Whinston (2016)
• Options to own/ put options may induce efficient
investments in hold-up problems.
- Hart (1995), Nöldeke and Schmidt (1995, 1998), Maskin and Tirole
(1999b)
54. Marginal contribution
• We study both effects in a setting with one-sided private
information and exogenous distribution of bargaining power.
• To the best of our knowledge, our paper is first to characterize
the optimal property right from a non-parametric class
(in a setting where the first best cannot in general be achieved).
• Attractive properties of option-to-own contracts were studied:
• Liability rules raise second-best efficiency in bargaining.
- Che (2006), Segal and Whinston (2016)
• Options to own/ put options may induce efficient
investments in hold-up problems.
- Hart (1995), Nöldeke and Schmidt (1995, 1998), Maskin and Tirole
(1999b)
• We provide an optimality foundation.
56. Marginal contribution
• The setting allows us to study market-design applications:
• optimal license design;
57. Marginal contribution
• The setting allows us to study market-design applications:
• optimal license design;
• regulating a private rental market;
58. Marginal contribution
• The setting allows us to study market-design applications:
• optimal license design;
• regulating a private rental market;
• optimal patent policy.
59. Marginal contribution
• The setting allows us to study market-design applications:
• optimal license design;
• regulating a private rental market;
• optimal patent policy.
• On the technical side:
60. Marginal contribution
• The setting allows us to study market-design applications:
• optimal license design;
• regulating a private rental market;
• optimal patent policy.
• On the technical side:
• We provide a novel solution method for mechanism design
with type-dependent outside options (Lewis and
Sappington, 1988, Jullien, 2000) based on an extension of
the ironing technique (Myerson, 1981).
61. Marginal contribution
• The setting allows us to study market-design applications:
• optimal license design;
• regulating a private rental market;
• optimal patent policy.
• On the technical side:
• We provide a novel solution method for mechanism design
with type-dependent outside options (Lewis and
Sappington, 1988, Jullien, 2000) based on an extension of
the ironing technique (Myerson, 1981).
• We show how to optimize over the outside-option function.
62. Other related papers
• Allocation mechanisms versus efficient investment:
Rogerson (1992), Bergemann and Välimäki (2002), Milgrom
(2017), Hatfield, Kojima, and Kominers (2019), Gershkov,
Moldovanu, Strack, and Zhang (2021), Akbarpour, Kominers, Li,
Li, and Milgrom (2023), ...
• Related techniques: Kleiner, Moldovanu, and Strack (2021),
Loertscher and Muir (2022), Kang (2023), Akbarpour R
Dworczak R
Kominers (2023),...
• Spectrum license design: Milgrom, Weyl and Zhang (2017),
Weyl and Zhang (2017), ...
• Optimal patent design: Matutes, Regibeau and Rockett (1996),
Wright (1999), Hopenhayn, Llobet and Mitchell (2006), ...
65. Model
• There is an agent, a designer, and a social planner;
• At time t = 0:
66. Model
• There is an agent, a designer, and a social planner;
• At time t = 0:
• The planner designs a contract (set of rights) that the agent
holds.
67. Model
• There is an agent, a designer, and a social planner;
• At time t = 0:
• The planner designs a contract (set of rights) that the agent
holds.
• At time t = 1:
68. Model
• There is an agent, a designer, and a social planner;
• At time t = 0:
• The planner designs a contract (set of rights) that the agent
holds.
• At time t = 1:
• The agent decides whether to invest at (sunk) cost c > 0;
69. Model
• There is an agent, a designer, and a social planner;
• At time t = 0:
• The planner designs a contract (set of rights) that the agent
holds.
• At time t = 1:
• The agent decides whether to invest at (sunk) cost c > 0;
• At time t = 2:
70. Model
• There is an agent, a designer, and a social planner;
• At time t = 0:
• The planner designs a contract (set of rights) that the agent
holds.
• At time t = 1:
• The agent decides whether to invest at (sunk) cost c > 0;
• At time t = 2:
• The agent’s (privately observed) type θ and a public state ω
are drawn from a joint distribution that depends on whether
the agent invested or not.
71. Model
• There is an agent, a designer, and a social planner;
• At time t = 0:
• The planner designs a contract (set of rights) that the agent
holds.
• At time t = 1:
• The agent decides whether to invest at (sunk) cost c > 0;
• At time t = 2:
• The agent’s (privately observed) type θ and a public state ω
are drawn from a joint distribution that depends on whether
the agent invested or not.
• The designer chooses a mechanism, and trade happens.
72. Model
Time t = 2 continued:
• Designer chooses a trading mechanism (xω(θ), tω(θ)), where
x ∈ [0, 1] denotes an allocation, and t ∈ R denotes a transfer;
73. Model
Time t = 2 continued:
• Designer chooses a trading mechanism (xω(θ), tω(θ)), where
x ∈ [0, 1] denotes an allocation, and t ∈ R denotes a transfer;
• Mechanism is chosen subject to IC and IR constraints, and must
respect the rights that the agent holds.
74. Model
Time t = 2 continued:
• Designer chooses a trading mechanism (xω(θ), tω(θ)), where
x ∈ [0, 1] denotes an allocation, and t ∈ R denotes a transfer;
• Mechanism is chosen subject to IC and IR constraints, and must
respect the rights that the agent holds.
• Designer maximizes V(θ, ω) · x + α · t, where α > 0.
75. Model
Time t = 2 continued:
• Designer chooses a trading mechanism (xω(θ), tω(θ)), where
x ∈ [0, 1] denotes an allocation, and t ∈ R denotes a transfer;
• Mechanism is chosen subject to IC and IR constraints, and must
respect the rights that the agent holds.
• Designer maximizes V(θ, ω) · x + α · t, where α > 0.
• Agent’s utility is θ · x − t.
77. Model
Agent’s problem at t = 1
• The agent decides whether to pay the cost c > 0 to invest.
• If the agent invests:
78. Model
Agent’s problem at t = 1
• The agent decides whether to pay the cost c > 0 to invest.
• If the agent invests:
• ω ∼ G, θ ∼ Fω.
79. Model
Agent’s problem at t = 1
• The agent decides whether to pay the cost c > 0 to invest.
• If the agent invests:
• ω ∼ G, θ ∼ Fω.
• Otherwise:
80. Model
Agent’s problem at t = 1
• The agent decides whether to pay the cost c > 0 to invest.
• If the agent invests:
• ω ∼ G, θ ∼ Fω.
• Otherwise:
• ω ∼ G, θ ∼ Fω, with Fω FOSD Fω, for every ω.
81. Model
Agent’s problem at t = 1
• The agent decides whether to pay the cost c 0 to invest.
• If the agent invests:
• ω ∼ G, θ ∼ Fω.
• Otherwise:
• ω ∼ G, θ ∼ Fω, with Fω FOSD Fω, for every ω.
• In the non-contractible case, the mechanism at t = 2 and the
planner’s contract do not depend on the investment decision.
82. Model
Agent’s problem at t = 1
• The agent decides whether to pay the cost c 0 to invest.
• If the agent invests:
• ω ∼ G, θ ∼ Fω.
• Otherwise:
• ω ∼ G, θ ∼ Fω, with Fω FOSD Fω, for every ω.
• In the non-contractible case, the mechanism at t = 2 and the
planner’s contract do not depend on the investment decision.
• In the contractible case, the mechanism at t = 2 and the
planner’s contract are contingent on the investment decision.
83. Model
Social planner’s problem at t = 0
• Social planner chooses a contract that is a menu of “rights”
M = {(xi, ti)}i∈I,
where xi ∈ [0, 1], ti ∈ R, and set I is arbitrary (M is compact).
84. Model
Social planner’s problem at t = 0
• Social planner chooses a contract that is a menu of “rights”
M = {(xi, ti)}i∈I,
where xi ∈ [0, 1], ti ∈ R, and set I is arbitrary (M is compact).
• The agent can “execute” any one of these rights at t = 2.
85. Model
Social planner’s problem at t = 0
• Social planner chooses a contract that is a menu of “rights”
M = {(xi, ti)}i∈I,
where xi ∈ [0, 1], ti ∈ R, and set I is arbitrary (M is compact).
• The agent can “execute” any one of these rights at t = 2.
• Social planner maximizes V?(θ, ω)x + α?t, where α? ≥ 0.
86. Model
Social planner’s problem at t = 0
• Social planner chooses a contract that is a menu of “rights”
M = {(xi, ti)}i∈I,
where xi ∈ [0, 1], ti ∈ R, and set I is arbitrary (M is compact).
• The agent can “execute” any one of these rights at t = 2.
• Social planner maximizes V?(θ, ω)x + α?t, where α? ≥ 0.
87. Model
Social planner’s problem at t = 0
• Social planner chooses a contract that is a menu of “rights”
M = {(xi, ti)}i∈I,
where xi ∈ [0, 1], ti ∈ R, and set I is arbitrary (M is compact).
• The agent can “execute” any one of these rights at t = 2.
• Social planner maximizes V?(θ, ω)x + α?t, where α? ≥ 0.
Assume: Investment is preferred by the social planner to no
investment; investment can be induced by some contract; but it is not
induced if the agent holds no rights.
88. Model
Social planner’s problem at t = 0
• Social planner chooses a contract that is a menu of “rights”
M = {(xi, ti)}i∈I,
where xi ∈ [0, 1], ti ∈ R, and set I is arbitrary (M is compact).
• The agent can “execute” any one of these rights at t = 2.
• Social planner maximizes V?(θ, ω)x + α?t, where α? ≥ 0.
Technicalities: Θ ≡ [θ, θ̄] is a compact subset of R; V and V? are
continuous in θ (and measurable in ω), F has a continuous positive
density on Θ.
89. Comments about the model
• A contract creates an outside option for the agent: Designer
must guarantee that the agent’s type-θ utility from participating in
the mechanism is not lower than
max
i∈I
{θxi − ti} .
90. Comments about the model
• A contract creates an outside option for the agent: Designer
must guarantee that the agent’s type-θ utility from participating in
the mechanism is not lower than
max
i∈I
{θxi − ti} .
• The framework captures many conventional rights:
91. Comments about the model
• A contract creates an outside option for the agent: Designer
must guarantee that the agent’s type-θ utility from participating in
the mechanism is not lower than
max
i∈I
{θxi − ti} .
• The framework captures many conventional rights:
• Property right: M = {(x = 1, t = 0)};
92. Comments about the model
• A contract creates an outside option for the agent: Designer
must guarantee that the agent’s type-θ utility from participating in
the mechanism is not lower than
max
i∈I
{θxi − ti} .
• The framework captures many conventional rights:
• Property right: M = {(x = 1, t = 0)};
• Cash payment: M = {(0, −p)};
93. Comments about the model
• A contract creates an outside option for the agent: Designer
must guarantee that the agent’s type-θ utility from participating in
the mechanism is not lower than
max
i∈I
{θxi − ti} .
• The framework captures many conventional rights:
• Property right: M = {(x = 1, t = 0)};
• Cash payment: M = {(0, −p)};
• Property right with a resale option: M = {(1, 0), (0, −p)};
94. Comments about the model
• A contract creates an outside option for the agent: Designer
must guarantee that the agent’s type-θ utility from participating in
the mechanism is not lower than
max
i∈I
{θxi − ti} .
• The framework captures many conventional rights:
• Property right: M = {(x = 1, t = 0)};
• Cash payment: M = {(0, −p)};
• Property right with a resale option: M = {(1, 0), (0, −p)};
• Renewable lease/ option to own: M = {(1, p)};
95. Comments about the model
• A contract creates an outside option for the agent: Designer
must guarantee that the agent’s type-θ utility from participating in
the mechanism is not lower than
max
i∈I
{θxi − ti} .
• The framework captures many conventional rights:
• Property right: M = {(x = 1, t = 0)};
• Cash payment: M = {(0, −p)};
• Property right with a resale option: M = {(1, 0), (0, −p)};
• Renewable lease/ option to own: M = {(1, p)};
• Partial property right: M = {(y, 0)}, where y ∈ (0, 1);
96. Comments about the model
• A contract creates an outside option for the agent: Designer
must guarantee that the agent’s type-θ utility from participating in
the mechanism is not lower than
max
i∈I
{θxi − ti} .
• The framework captures many conventional rights:
• Property right: M = {(x = 1, t = 0)};
• Cash payment: M = {(0, −p)};
• Property right with a resale option: M = {(1, 0), (0, −p)};
• Renewable lease/ option to own: M = {(1, p)};
• Partial property right: M = {(y, 0)}, where y ∈ (0, 1);
• Flexible property right: M = {s, p(s))}s∈[0, 1].
98. Comments about the model
• There are two frictions in the model:
1. Divergence of preferences between the planner and
designer (“ex-post inefficiency”);
99. Comments about the model
• There are two frictions in the model:
1. Divergence of preferences between the planner and
designer (“ex-post inefficiency”);
2. Non-contractible investment decision (“hold-up problem”);
100. Comments about the model
• There are two frictions in the model:
1. Divergence of preferences between the planner and
designer (“ex-post inefficiency”);
2. Non-contractible investment decision (“hold-up problem”);
• Additionally, we limited the power of property rights by assuming
that they cannot be state-contingent (“incomplete contracts”);
101. Comments about the model
• There are two frictions in the model:
1. Divergence of preferences between the planner and
designer (“ex-post inefficiency”);
2. Non-contractible investment decision (“hold-up problem”);
• Additionally, we limited the power of property rights by assuming
that they cannot be state-contingent (“incomplete contracts”);
• We can “switch off” some frictions and provide tighter results.
102. Comments about the model
• There are two frictions in the model:
1. Divergence of preferences between the planner and
designer (“ex-post inefficiency”);
2. Non-contractible investment decision (“hold-up problem”);
• Additionally, we limited the power of property rights by assuming
that they cannot be state-contingent (“incomplete contracts”);
• We can “switch off” some frictions and provide tighter results.
• Uninteresting cases:
103. Comments about the model
• There are two frictions in the model:
1. Divergence of preferences between the planner and
designer (“ex-post inefficiency”);
2. Non-contractible investment decision (“hold-up problem”);
• Additionally, we limited the power of property rights by assuming
that they cannot be state-contingent (“incomplete contracts”);
• We can “switch off” some frictions and provide tighter results.
• Uninteresting cases:
• If there is no investment and the planner and designer are
aligned, it is optimal to allocate no rights to the agent.
104. Comments about the model
• There are two frictions in the model:
1. Divergence of preferences between the planner and
designer (“ex-post inefficiency”);
2. Non-contractible investment decision (“hold-up problem”);
• Additionally, we limited the power of property rights by assuming
that they cannot be state-contingent (“incomplete contracts”);
• We can “switch off” some frictions and provide tighter results.
• Uninteresting cases:
• If there is no investment and the planner and designer are
aligned, it is optimal to allocate no rights to the agent.
• If the designer did not care about her revenue (α = 0), she would
“buy out” the agent’s rights.
112. Main result
Theorem
There exists an optimal contract that takes the form
M? = {(1, p), (y, p0)} for some p, p0 ∈ R and y ∈ [0, 1).
113. Main result
Theorem
There exists an optimal contract that takes the form
M? = {(1, p), (y, p0)} for some p, p0 ∈ R and y ∈ [0, 1).
Comments:
• The optimal contract is simple in that it consists of at most two
types of rights.
114. Main result
Theorem
There exists an optimal contract that takes the form
M? = {(1, p), (y, p0)} for some p, p0 ∈ R and y ∈ [0, 1).
Comments:
• The optimal contract is simple in that it consists of at most two
types of rights.
• One of the rights can be taken to be an option to own.
115. Main result
Theorem
There exists an optimal contract that takes the form
M? = {(1, p), (y, p0)} for some p, p0 ∈ R and y ∈ [0, 1).
Comments:
• The optimal contract is simple in that it consists of at most two
types of rights.
• One of the rights can be taken to be an option to own.
• If there were no hold-up problem in the model, M? = {(1, p)}
would be always optimal.
116. Step 1: Outside option constraint
Lemma
A choice of contract M by the social planner is equivalent to choosing
an outside option function R(θ) for the agent in the second-period
mechanism, where R(θ) is non-negative, non-decreasing, convex,
and has slope bounded above by 1.
117. Step 1: Outside option constraint
Lemma
A choice of contract M by the social planner is equivalent to choosing
an outside option function R(θ) for the agent in the second-period
mechanism, where R(θ) is non-negative, non-decreasing, convex,
and has slope bounded above by 1.
The lemma follows immediately from the observation that, for any M,
we can set
R(θ) = max{0, max
i∈I
{xiθ − ti}}.
118. Step 1: Outside option constraint
Lemma
A choice of contract M by the social planner is equivalent to choosing
an outside option function R(θ) for the agent in the second-period
mechanism, where R(θ) is non-negative, non-decreasing, convex,
and has slope bounded above by 1.
The lemma follows immediately from the observation that, for any M,
we can set
R(θ) = max{0, max
i∈I
{xiθ − ti}}.
The planner maximizes over type-dependent outside options for
the agent.
119. Step 1: Outside option constraint
Fixing ω (and dropping it from the notation), the designer solves:
max
x:Θ→[0,1], u≥0
Z θ
θ
W(θ)x(θ)dθ − αu
s.t. x is non-decreasing;
U(θ) ≡ u +
Z θ
θ
x(τ) dτ ≥ R(θ), ∀θ ∈ Θ,
where
W(θ) ≡ (V(θ) + αB(θ)) f(θ),
and
B(θ) = θ −
1 − F(θ)
f(θ)
.
120. Step 1: Outside option constraint
Fixing ω (and dropping it from the notation), the designer solves:
max
x:Θ→[0,1], u≥0
Z θ
θ
W(θ)x(θ)dθ − αu
s.t. x is non-decreasing;
U(θ) ≡ u +
Z θ
θ
x(τ) dτ ≥ R(θ), ∀θ ∈ Θ,
where
W(θ) ≡ (V(θ) + αB(θ)) f(θ),
and
B(θ) = θ −
1 − F(θ)
f(θ)
.
This is a problem considered by Jullien (2000).
121. Step 2: Ironing Jullien (2000)
• Naively, the designer wants to set x(θ) = 1 when W(θ) 0, and
set x(θ) to be as low as possible (given R) when W(θ) 0.
122. Step 2: Ironing Jullien (2000)
• Naively, the designer wants to set x(θ) = 1 when W(θ) 0, and
set x(θ) to be as low as possible (given R) when W(θ) 0.
• There are three complications:
123. Step 2: Ironing Jullien (2000)
• Naively, the designer wants to set x(θ) = 1 when W(θ) 0, and
set x(θ) to be as low as possible (given R) when W(θ) 0.
• There are three complications:
• this may violate monotonicity of x(θ);
124. Step 2: Ironing Jullien (2000)
• Naively, the designer wants to set x(θ) = 1 when W(θ) 0, and
set x(θ) to be as low as possible (given R) when W(θ) 0.
• There are three complications:
• this may violate monotonicity of x(θ);
• x(θ) cannot be minimized point-wise, because allocation to
type θ affects the utility of higher types;
125. Step 2: Ironing Jullien (2000)
• Naively, the designer wants to set x(θ) = 1 when W(θ) 0, and
set x(θ) to be as low as possible (given R) when W(θ) 0.
• There are three complications:
• this may violate monotonicity of x(θ);
• x(θ) cannot be minimized point-wise, because allocation to
type θ affects the utility of higher types;
• the designer may want to use the transfer to satisfy the
outside-option constraint.
126. Step 2: Ironing Jullien (2000)
• Naively, the designer wants to set x(θ) = 1 when W(θ) 0, and
set x(θ) to be as low as possible (given R) when W(θ) 0.
• There are three complications:
• this may violate monotonicity of x(θ);
• x(θ) cannot be minimized point-wise, because allocation to
type θ affects the utility of higher types;
• the designer may want to use the transfer to satisfy the
outside-option constraint.
• These complications can be addressed by adapting the ironing
technique from Myerson (1981).
127. Step 2: Ironing Jullien (2000)
• Naively, the designer wants to set x(θ) = 1 when W(θ) 0, and
set x(θ) to be as low as possible (given R) when W(θ) 0.
• There are three complications:
• this may violate monotonicity of x(θ);
• x(θ) cannot be minimized point-wise, because allocation to
type θ affects the utility of higher types;
• the designer may want to use the transfer to satisfy the
outside-option constraint.
• These complications can be addressed by adapting the ironing
technique from Myerson (1981).
• Define
W(θ) =
Z θ̄
θ
W(τ)dτ, W = co(W).
134. Step 2: Ironing Jullien (2000)
• Why does ironing work?
• The outside option constraint is:
u +
Z θ
θ
x(τ)dτ ≡U(θ) ≥ R(θ)≡ u0 +
Z θ
θ
x0(τ)dτ.
135. Step 2: Ironing Jullien (2000)
• Why does ironing work?
• The outside option constraint is:
u +
Z θ
θ
x(τ)dτ ≡ U(θ) ≥ R(θ) ≡ u0 +
Z θ
θ
x0(τ)dτ.
136. Step 2: Ironing Jullien (2000)
• Why does ironing work?
• The outside option constraint is:
u +
Z θ
θ
x(τ)dτ ≥ u0 +
Z θ
θ
x0(τ)dτ.
137. Step 2: Ironing Jullien (2000)
• Why does ironing work?
• The outside option constraint is:
u +
Z θ
θ
x(τ)dτ ≥ u0 +
Z θ
θ
x0(τ)dτ.
• This is (almost) a second-order stochastic dominance
constraint if x and x0 are treated as CDFs.
138. Step 2: Ironing Jullien (2000)
• Why does ironing work?
• The outside option constraint is:
u +
Z θ
θ
x(τ)dτ ≥ u0 +
Z θ
θ
x0(τ)dτ.
• This is (almost) a second-order stochastic dominance
constraint if x and x0 are treated as CDFs.
• Ironing corresponds to taking a mean-preserving spread of the
distribution—it preserves the outside-option constraint.
139. Step 2: Ironing Jullien (2000)
• Why does ironing work?
• The outside option constraint is:
u +
Z θ
θ
x(τ)dτ ≥ u0 +
Z θ
θ
x0(τ)dτ.
• This is (almost) a second-order stochastic dominance
constraint if x and x0 are treated as CDFs.
• Ironing corresponds to taking a mean-preserving spread of the
distribution—it preserves the outside-option constraint.
• Related work: Kleiner, Moldovanu, and Strack (2021), Loertscher
and Muir (2022), Akbarpour R
Dworczak R
Kominers (2023)
140. Step 3: Linearity of the planner’s problem
We now go back to t = 0.
141. Step 3: Linearity of the planner’s problem
We now go back to t = 0.
Lemma (Linearity)
The planner’s problem of choosing the optimal contract M is linear in
the outside option R(θ).
142. Step 3: Linearity of the planner’s problem
We now go back to t = 0.
Lemma (Linearity)
The planner’s problem of choosing the optimal contract M is linear in
the outside option R(θ).
• By the above construction, the optimal allocation rule x?(θ) for
the designer depends linearly on R(θ).
143. Step 3: Linearity of the planner’s problem
We now go back to t = 0.
Lemma (Linearity)
The planner’s problem of choosing the optimal contract M is linear in
the outside option R(θ).
• By the above construction, the optimal allocation rule x?(θ) for
the designer depends linearly on R(θ).
• Key intuition: The set of types at which the outside-option
constraint binds is pinned down by the distribution of agent’s type
and designer’s preferences—it does not depend on R itself!
144. Step 3: Linearity of the planner’s problem
We now go back to t = 0.
Lemma (Linearity)
The planner’s problem of choosing the optimal contract M is linear in
the outside option R(θ).
• By the above construction, the optimal allocation rule x?(θ) for
the designer depends linearly on R(θ).
• Key intuition: The set of types at which the outside-option
constraint binds is pinned down by the distribution of agent’s type
and designer’s preferences—it does not depend on R itself!
• Both the planner’s objective and the agent’s
investment-obedience constraint are linear in x?.
145. Step 4: Wrapping up
Lemma
The planner’s problem of choosing the optimal contract M is
equivalent to choosing a probability distribution and a scalar to
maximize a linear objective subject to single linear constraint.
146. Step 4: Wrapping up
Lemma
The planner’s problem of choosing the optimal contract M is
equivalent to choosing a probability distribution and a scalar to
maximize a linear objective subject to single linear constraint.
• Using the representation R(θ) ≡ u0 +
R θ
θ x0(τ)dτ, we can
optimize over x0 (treated as a distribution) and u0.
147. Step 4: Wrapping up
Lemma
The planner’s problem of choosing the optimal contract M is
equivalent to choosing a probability distribution and a scalar to
maximize a linear objective subject to single linear constraint.
• Using the representation R(θ) ≡ u0 +
R θ
θ x0(τ)dτ, we can
optimize over x0 (treated as a distribution) and u0.
• There exists an optimal solution such that the probability
distribution has support of size at most two (e.g., Bergemann et
al., 2018; Le Treust and Tomala, 2019; Doval and Skreta, 2022).
148. Step 4: Wrapping up
Lemma
The planner’s problem of choosing the optimal contract M is
equivalent to choosing a probability distribution and a scalar to
maximize a linear objective subject to single linear constraint.
• Using the representation R(θ) ≡ u0 +
R θ
θ x0(τ)dτ, we can
optimize over x0 (treated as a distribution) and u0.
• There exists an optimal solution such that the probability
distribution has support of size at most two (e.g., Bergemann et
al., 2018; Le Treust and Tomala, 2019; Doval and Skreta, 2022).
• This gives us two items in the optimal menu.
149. Corollaries of the proof
• With no constraint, the problem is to maximize a linear objective
=⇒ solution is an extreme point
=⇒ option to own is optimal.
150. Corollaries of the proof
• With no constraint, the problem is to maximize a linear objective
=⇒ solution is an extreme point
=⇒ option to own is optimal.
• Easy extension to K linear constraints
=⇒ We need at most K + 1 options in the optimal menu.
151. Corollaries of the proof
• With no constraint, the problem is to maximize a linear objective
=⇒ solution is an extreme point
=⇒ option to own is optimal.
• Easy extension to K linear constraints
=⇒ We need at most K + 1 options in the optimal menu.
• Extension to continuous investment:
152. Corollaries of the proof
• With no constraint, the problem is to maximize a linear objective
=⇒ solution is an extreme point
=⇒ option to own is optimal.
• Easy extension to K linear constraints
=⇒ We need at most K + 1 options in the optimal menu.
• Extension to continuous investment:
• Suppose agent chooses e ∈ [0, 1] at strictly convex cost
c(e), and e is the probability that θ is drawn from Fω.
153. Corollaries of the proof
• With no constraint, the problem is to maximize a linear objective
=⇒ solution is an extreme point
=⇒ option to own is optimal.
• Easy extension to K linear constraints
=⇒ We need at most K + 1 options in the optimal menu.
• Extension to continuous investment:
• Suppose agent chooses e ∈ [0, 1] at strictly convex cost
c(e), and e is the probability that θ is drawn from Fω.
• Satisfying FOC at the target investment level e? is sufficient
for obedience.
154. Corollaries of the proof
• With no constraint, the problem is to maximize a linear objective
=⇒ solution is an extreme point
=⇒ option to own is optimal.
• Easy extension to K linear constraints
=⇒ We need at most K + 1 options in the optimal menu.
• Extension to continuous investment:
• Suppose agent chooses e ∈ [0, 1] at strictly convex cost
c(e), and e is the probability that θ is drawn from Fω.
• Satisfying FOC at the target investment level e? is sufficient
for obedience.
• FOC is linear in R(θ) =⇒ we need two options in the
optimal menu.
155. The monotone case
Assume that:
• Buyer and seller virtual surpluses are monotone:
B(θ) ≡ θ −
1 − F(θ)
f(θ)
and
S(θ) ≡ θ +
F(θ)
f(θ)
are non-decreasing in θ;
• Both the planner’s and the designer’s objective functions
V?(θ, ω) and V(θ, ω) are non-decreasing in the agent’s type θ.
157. The monotone case
Lemma (The monotone case)
For any outside option function R(θ), the mechanism designer in the
second period will choose an optimal mechanism in which the
outside-option constraint binds for types in the interval [θ?
ω, θ̄?
ω].
158. The monotone case
Lemma (The monotone case)
For any outside option function R(θ), the mechanism designer in the
second period will choose an optimal mechanism in which the
outside-option constraint binds for types in the interval [θ?
ω, θ̄?
ω].
Moreover, except for the case of a boundary solution,
V(θ?
ω, ω) + αS(θ?
ω) = 0,
V(θ̄?
ω, ω) + αB(θ̄?
ω) = 0.
159. The monotone case
Lemma (The monotone case)
For any outside option function R(θ), the mechanism designer in the
second period will choose an optimal mechanism in which the
outside-option constraint binds for types in the interval [θ?
ω, θ̄?
ω].
Moreover, except for the case of a boundary solution,
V(θ?
ω, ω) + αS(θ?
ω) = 0,
V(θ̄?
ω, ω) + αB(θ̄?
ω) = 0.
• For θ ≥ θ̄?
ω, the designer wants to allocate the good to the agent
anyway, so the outside-option constraint is slack;
160. The monotone case
Lemma (The monotone case)
For any outside option function R(θ), the mechanism designer in the
second period will choose an optimal mechanism in which the
outside-option constraint binds for types in the interval [θ?
ω, θ̄?
ω].
Moreover, except for the case of a boundary solution,
V(θ?
ω, ω) + αS(θ?
ω) = 0,
V(θ̄?
ω, ω) + αB(θ̄?
ω) = 0.
• For θ ≥ θ̄?
ω, the designer wants to allocate the good to the agent
anyway, so the outside-option constraint is slack;
161. The monotone case
Lemma (The monotone case)
For any outside option function R(θ), the mechanism designer in the
second period will choose an optimal mechanism in which the
outside-option constraint binds for types in the interval [θ?
ω, θ̄?
ω].
Moreover, except for the case of a boundary solution,
V(θ?
ω, ω) + αS(θ?
ω) = 0,
V(θ̄?
ω, ω) + αB(θ̄?
ω) = 0.
• For θ ≥ θ̄?
ω, the designer wants to allocate the good to the agent
anyway, so the outside-option constraint is slack;
• For θ ≤ θ?
ω, the designer prefers to “buy out” the rights using a
monetary payment, so the constraint is again slack.
163. The monotone case
Suppose that the cost of investment c is sufficiently high.
Proposition
When the investment decision of the agent is contractible, the
planner optimally chooses a menu of the form M? = {(1, p), (0, −p0)}
for some p ∈ R and p0 ∈ R+.
164. The monotone case
Suppose that the cost of investment c is sufficiently high.
Proposition
When the investment decision of the agent is contractible, the
planner optimally chooses a menu of the form M? = {(1, p), (0, −p0)}
for some p ∈ R and p0 ∈ R+.
When the investment decision of the agent is not contractible, the
planner optimally chooses a menu of the form M? = {(1, p), (y, 0)}
for some p ∈ R and y ∈ [0, 1).
165. The monotone case
Suppose that the cost of investment c is sufficiently high.
Proposition
When the investment decision of the agent is contractible, the
planner optimally chooses a menu of the form M? = {(1, p), (0, −p0)}
for some p ∈ R and p0 ∈ R+.
When the investment decision of the agent is not contractible, the
planner optimally chooses a menu of the form M? = {(1, p), (y, 0)}
for some p ∈ R and y ∈ [0, 1).
• When investment is contractible, offering a cash payment for
investment is effective.
166. The monotone case
Suppose that the cost of investment c is sufficiently high.
Proposition
When the investment decision of the agent is contractible, the
planner optimally chooses a menu of the form M? = {(1, p), (0, −p0)}
for some p ∈ R and p0 ∈ R+.
When the investment decision of the agent is not contractible, the
planner optimally chooses a menu of the form M? = {(1, p), (y, 0)}
for some p ∈ R and y ∈ [0, 1).
• When investment is contractible, offering a cash payment for
investment is effective.
• When investment is not contractible, the planner can incentivize
investment only by shifting more rents to higher types.
168. Application #1: Dynamic resource allocation
• Players:
• Agent: Firm
• Planner: Regulator
• Designer: Regulator
• Agent invests in infrastructure determining value θ;
• State ω represents the value for an alternative use;
• The planner maximizes a combination of efficiency and revenue:
V?(θ, ω)x + α?t = (θ − ω)x + α?t.
• The designer might put more weight on revenue:
V(θ, ω)x + α t = (θ − ω)x + α t, where α ≥ α?.
169. Application #1: Dynamic resource allocation
• In the monotone case when investment is not contractible, the
optimal license is a partial property right plus an option to own.
170. Application #1: Dynamic resource allocation
• In the monotone case when investment is not contractible, the
optimal license is a partial property right plus an option to own.
• Suppose that Fω is uniform on [0, 1], and Fω is an atom at 0.
171. Application #1: Dynamic resource allocation
• In the monotone case when investment is not contractible, the
optimal license is a partial property right plus an option to own.
• Suppose that Fω is uniform on [0, 1], and Fω is an atom at 0.
• The optimal property right as a function of value for revenue:
172. Application #1: Dynamic resource allocation
• In the monotone case when investment is not contractible, the
optimal license is a partial property right plus an option to own.
• Suppose that Fω is uniform on [0, 1], and Fω is an atom at 0.
• The optimal property right as a function of value for revenue:
• α = α? = 1: option to own (1, p)
(p makes the investment-obedience constraint bind);
173. Application #1: Dynamic resource allocation
• In the monotone case when investment is not contractible, the
optimal license is a partial property right plus an option to own.
• Suppose that Fω is uniform on [0, 1], and Fω is an atom at 0.
• The optimal property right as a function of value for revenue:
• α = α? = 1: option to own (1, p)
(p makes the investment-obedience constraint bind);
• α = 1, α? = 0: partial property right (0, y)
(y makes the investment-obedience constraint bind);
174. Application #1: Dynamic resource allocation
• In the monotone case when investment is not contractible, the
optimal license is a partial property right plus an option to own.
• Suppose that Fω is uniform on [0, 1], and Fω is an atom at 0.
• The optimal property right as a function of value for revenue:
• α = α? = 1: option to own (1, p)
(p makes the investment-obedience constraint bind);
• α = 1, α? = 0: partial property right (0, y)
(y makes the investment-obedience constraint bind);
• α = α? = 0: no right
(consistent with Rogerson (1992))
175. Application #2: Regulating a private rental market
• Players:
• Agent: Tenant
• Planner: Regulator
• Designer: Rental company
• Agent invests in the property determining her value θ for staying.
• The state ω is the seller’s outside option (market rental price).
• The seller wants to maximize revenue:
V(θ, ω)x + αt = −ωx + t.
• The planner wants to maximize efficiency:
V?(θ, ω)x + α?t = (θ − ω)x.
176. Application #2: Regulating a private rental market
• Suppose that without investment, value θ is uniform on [0, 1];
with investment, the value is drawn from [∆, 1 + ∆] instead.
177. Application #2: Regulating a private rental market
• Suppose that without investment, value θ is uniform on [0, 1];
with investment, the value is drawn from [∆, 1 + ∆] instead.
• Suppose that ω is known (and lies in a certain range).
178. Application #2: Regulating a private rental market
• Suppose that without investment, value θ is uniform on [0, 1];
with investment, the value is drawn from [∆, 1 + ∆] instead.
• Suppose that ω is known (and lies in a certain range).
• The optimal contract is a renewable lease with price
p?
= ω − γ∆,
where γ is the Lagrange multiplier on the investment constraint.
179. Application #2: Regulating a private rental market
• Suppose that without investment, value θ is uniform on [0, 1];
with investment, the value is drawn from [∆, 1 + ∆] instead.
• Suppose that ω is known (and lies in a certain range).
• The optimal contract is a renewable lease with price
p?
= ω − γ∆,
where γ is the Lagrange multiplier on the investment constraint.
• If investment constraint is slack, p? = ω, so the planner “forces”
the seller to use a VCG mechanism.
180. Application #2: Regulating a private rental market
• Suppose that without investment, value θ is uniform on [0, 1];
with investment, the value is drawn from [∆, 1 + ∆] instead.
• Suppose that ω is known (and lies in a certain range).
• The optimal contract is a renewable lease with price
p?
= ω − γ∆,
where γ is the Lagrange multiplier on the investment constraint.
• If investment constraint is slack, p? = ω, so the planner “forces”
the seller to use a VCG mechanism.
• If ω is random, then (assuming interior solution)
p?
= E[ ω | θ?
ω ≤ p?
≤ θ
?
ω] − γ∆.
181. Application #3: Vaccine development
• Players:
• Agent: Pharmaceutical company
• Planner: Health agency
• Designer: Health agency
• Company develops a vaccine; the marginal cost of production
conditional on investment is k ∼ e
F (θ = −k);
• Allocation x is the number of units purchased by the health
agency, with 1 being the mass of the patient population;
• Health agency maximizes the total value of allocation,
V?(θ, ω)x = V(θ, ω)x = ωx,
where ω measures the severity of the health crisis.
• Assume that 1 = α ≥ α?.
182. Application #3: Vaccine development
• Assume that investment is observable and that ω is known.
183. Application #3: Vaccine development
• Assume that investment is observable and that ω is known.
• The optimal contract, for c high enough, is a cash payment for
the investment, plus a guaranteed sale price equal to
p?
= min
n ω
α?
, k̄
o
.
184. Application #3: Vaccine development
• Assume that investment is observable and that ω is known.
• The optimal contract, for c high enough, is a cash payment for
the investment, plus a guaranteed sale price equal to
p?
= min
n ω
α?
, k̄
o
.
• If the planner cares about revenue as much as the designer, she
sets a price equal to ω, as if she maximized efficiency.
185. Application #3: Vaccine development
• Assume that investment is observable and that ω is known.
• The optimal contract, for c high enough, is a cash payment for
the investment, plus a guaranteed sale price equal to
p?
= min
n ω
α?
, k̄
o
.
• If the planner cares about revenue as much as the designer, she
sets a price equal to ω, as if she maximized efficiency.
• For α? close enough to 0, the optimal contract is a guaranteed
sale (for all producer types).
186. Application #3: Vaccine development
• If ω is stochastic, then the optimal price satisfies
p?
= min
(
E
ω|ω ∈ [ωp? , ω̄p? ]
α?
, k̄
)
,
where [ωp? , ω̄p? ] is the interval of ω’s for which the choice of p?
changes the second-period mechanism.
187. Application #3: Vaccine development
• If ω is stochastic, then the optimal price satisfies
p?
= min
(
E
ω|ω ∈ [ωp? , ω̄p? ]
α?
, k̄
)
,
where [ωp? , ω̄p? ] is the interval of ω’s for which the choice of p?
changes the second-period mechanism.
• If the realized ω is high (health crisis is severe), the designer will
offer a price better than p?.
188. Application #3: Vaccine development
• If ω is stochastic, then the optimal price satisfies
p?
= min
(
E
ω|ω ∈ [ωp? , ω̄p? ]
α?
, k̄
)
,
where [ωp? , ω̄p? ] is the interval of ω’s for which the choice of p?
changes the second-period mechanism.
• If the realized ω is high (health crisis is severe), the designer will
offer a price better than p?.
• If the realized ω is low (health crisis is mild), the designer will
offer a price lower than p? and compensate the producer with an
additional cash payment (on top of the payment for investment).
189. Application #4: Patent policy
• Players:
• Agent: Firm
• Planner: Regulator
• Designer: Patent agency
• Firm invests in a new technology; if investment is made, the firm
can produce at constant marginal cost k ∼ F̃.
• Conditional on x = 1, the firm provides a monopoly quantity to
maximize profits; conditional on x = 0, the firm competes in a
competitive market. Market demand is D(p) = 1 − p.
• The regulator and the patent agency maximize consumer
surplus with weight ω (but attach a positive weight to revenue).
190. Application #4: Patent policy
• This setting maps into our framework with θ = 1
4 (1 − k)2 and
V?
(θ; ω) = V(θ; ω) = −
3
2
ωθ.
191. Application #4: Patent policy
• This setting maps into our framework with θ = 1
4 (1 − k)2 and
V?
(θ; ω) = V(θ; ω) = −
3
2
ωθ.
• Perfect competition is more beneficial when marginal cost is low.
192. Application #4: Patent policy
• This setting maps into our framework with θ = 1
4 (1 − k)2 and
V?
(θ; ω) = V(θ; ω) = −
3
2
ωθ.
• Perfect competition is more beneficial when marginal cost is low.
• Suppose that the density of θ is non-decreasing, and the weight
on revenue α is small enough.
193. Application #4: Patent policy
• This setting maps into our framework with θ = 1
4 (1 − k)2 and
V?
(θ; ω) = V(θ; ω) = −
3
2
ωθ.
• Perfect competition is more beneficial when marginal cost is low.
• Suppose that the density of θ is non-decreasing, and the weight
on revenue α is small enough.
• Then, an optimal contract is to offer full patent protection to the
invention (x = 1) with exogenous probability y ∈ (0, 1] at no
payment.
194. Application #5: Supply chain contracting
• Players:
• Agent: Small supplier
• Planner: Large producer
• Designer: Large producer
• Producer buys some amount x of inputs from the supplier.
• The supplier must invest at time t = 1 in relationship-specific
technology to produce the inputs at marginal cost c ≡ −θ.
• Through the interaction with the supplier, the large firm can learn
the supplier’s costs: The state ω is a noisy signal of θ.
• Producer maximizes profits having a constant marginal value 1
for each unit of the input: Vω(θ) = 1 and α = 1.
• Producer proposes a contract: V?
ω(θ) = 1 and α? = 1.
195. Application #5: Supply chain contracting
• Suppose investment by the small supplier is not contractible.
196. Application #5: Supply chain contracting
• Suppose investment by the small supplier is not contractible.
• The producer will in general commit to a two-price scheme,
committing to buy up to y units at some price pH, and any
number of units at some lower price pL.
197. Application #5: Supply chain contracting
• Suppose investment by the small supplier is not contractible.
• The producer will in general commit to a two-price scheme,
committing to buy up to y units at some price pH, and any
number of units at some lower price pL.
• If investment by the small supplier is contractible, assuming the
cost of investment is high enough, the producer will offer an
upfront payment for setting up production and a guaranteed
purchase price for any number of units.
199. Summary
• We introduced a simple but flexible framework for analyzing
optimal design of (property) rights.
200. Summary
• We introduced a simple but flexible framework for analyzing
optimal design of (property) rights.
• Optimally designed rights partially restore commitment to
future trading mechanisms.
201. Summary
• We introduced a simple but flexible framework for analyzing
optimal design of (property) rights.
• Optimally designed rights partially restore commitment to
future trading mechanisms.
• The optimal right often features an option to own.
202. Future steps
• Maskin-Tirole (1999) critique of incomplete contracts: Can the
planner do better by conditioning rights on the state in an
incentive-compatible way?
203. Future steps
• Maskin-Tirole (1999) critique of incomplete contracts: Can the
planner do better by conditioning rights on the state in an
incentive-compatible way?
• Consider designing a menu of menus M = {Mj}j such that the
designer selects a menu Mj based on realized state and the
agent chooses an option from Mj.
204. Future steps
• Maskin-Tirole (1999) critique of incomplete contracts: Can the
planner do better by conditioning rights on the state in an
incentive-compatible way?
• Consider designing a menu of menus M = {Mj}j such that the
designer selects a menu Mj based on realized state and the
agent chooses an option from Mj. This can help!
205. Future steps
• Maskin-Tirole (1999) critique of incomplete contracts: Can the
planner do better by conditioning rights on the state in an
incentive-compatible way?
• Consider designing a menu of menus M = {Mj}j such that the
designer selects a menu Mj based on realized state and the
agent chooses an option from Mj. This can help!
• What if both parties (at t = 2) have private information and
bargaining power is not exogenous?
206. Future steps
• Maskin-Tirole (1999) critique of incomplete contracts: Can the
planner do better by conditioning rights on the state in an
incentive-compatible way?
• Consider designing a menu of menus M = {Mj}j such that the
designer selects a menu Mj based on realized state and the
agent chooses an option from Mj. This can help!
• What if both parties (at t = 2) have private information and
bargaining power is not exogenous? Allocate rights to both
parties?
207. Future steps
• Maskin-Tirole (1999) critique of incomplete contracts: Can the
planner do better by conditioning rights on the state in an
incentive-compatible way?
• Consider designing a menu of menus M = {Mj}j such that the
designer selects a menu Mj based on realized state and the
agent chooses an option from Mj. This can help!
• What if both parties (at t = 2) have private information and
bargaining power is not exogenous? Allocate rights to both
parties?
• What if the planner can prohibit the usage of certain
allocation-transfer pairs by the designer?
208. Future steps
• Maskin-Tirole (1999) critique of incomplete contracts: Can the
planner do better by conditioning rights on the state in an
incentive-compatible way?
• Consider designing a menu of menus M = {Mj}j such that the
designer selects a menu Mj based on realized state and the
agent chooses an option from Mj. This can help!
• What if both parties (at t = 2) have private information and
bargaining power is not exogenous? Allocate rights to both
parties?
• What if the planner can prohibit the usage of certain
allocation-transfer pairs by the designer?
• Optimal allocation of contracts at t = 0 to multiple agents?