Behavioral contracting: Optimale Verträge auf Arbeitsmärkten

Martin Kocher

Behavioral Contracting.

Optimale Verträge auf

Arbeitsmärkten

Ringvorlesung Verhaltensökonomik

Universität Mannheim, 26. Oktober 2011

26 October 2011 # 2Martin Kocher

Starting Point

How should contracts be designed if principals and agents are not all selfish and rational, if they exhibit feelings such as overconfidence, disappointment (aversion), other emotions.

It is very likely that such tendencies change the �“behaviorally�”optimal contracts. But how?

I am interested in the optimal design of contracts and the optimal design of institutions in such situations.

Straightforward applications are principal-agent (contract)

theory, public good provision, markets for private goods,�…

http://www.youtube.com/watch?v=sCKOpJQI6Iw&feature=related

Motivation

Paper 1Paper 2Paper 3


Basic idea

An extensive literature that started in the 1980ies.Prominent early contributions: Akerlof (1982); Fehr, Kirchsteiger and Riedl (1993).Influential papers by Ernst Fehr and Klaus Schmidt.Until very recently, almost all studies focused on a one-on-one matching of principals (employers) and agents (employees).The main focus of the research that will be presented today is on situations with multiple (at least two) agents.

Motivation



The gift-exchange game:Suppressing the time and individual indices (whenever not necessary), material period payoffs for the agent amounts to:

(1)The principal�’s material period payoff is given by:

(2)

where is a productivity parameter and n is the number of agents.Agents have to bear a cost of effort denoted by c(e) that is increasing in efforts with increasing marginal costs according to Table 1 (next slide).

Workhorse

c(e)-wA

n

ii

n

iiP we

11

Motivation



Cost-of-effort function

Table 1. Cost of Effort

e 1 2 3 4 5 6 7 8 9 10

c(e) 0 1 2 4 6 8 10 12 15 18

Motivation



Overview of talk

Studies on the topic:

Relational contracts with individual and uniform wages (withWolfgang Luhan and Matthias Sutter). Working Paper.Co-employment, tenure of contracts, and reciprocity (with Vera Angelova and Werner Güth). Working Paper; and Co-employment of permanently and temporarily employed agents(with Vera Angelova and Werner Güth). Labor Economics, forthcoming.

If time permits:Psychological pressure in competitive environments: New evidence from a randomized natural experiment (with Mark Lenz and Matthias Sutter). Management Science, forthcoming.The fair employment hypothesis (with Sebastian Strasser). Working Paper.

Motivation



Relational contracts

Relational contractswith individual and uniform wages

(with Wolfgang Luhan and Matthias Sutter)

MotivationPaper IPaper IIPaper III



Akerlof�’s (1982) gift exchange hypothesis actually consists of two aspects:

1. Workers reciprocate to above market-clearing wages by providing higher than minimal effort levels (the well-known fair wage-effort hypothesis).

2. They �“acquire sentiment for each other�” (p. 543). �“As a consequence of worker sentiment for one another, the firm cannot deal with each worker individually, but rather must at least to some extent treat the group of workers with the same norm, collectively�” (p. 544).




The fair uniform wage hypothesis stipulates that homogenous agents that are employed for a uniform wage level will, ceteris paribus, exert more effort, resulting in higher rents.In our experiment, principals interact with agents on a labor market. Principals have identical profit functions, and agents do not differ in their cost-of-effort functions and productivity levels.We introduce two straightforward experimental treatments:(i) an individual contract treatment, IC, in which principals can, but need not, employ workers for identical contracts, and (ii) a uniform contract treatment, UC, in which principals are forced to employ all agents at the same conditions (non-discriminatory clause).




In reality, one reason why different wages are paid for the same job and homogenous workers is often a different tenure of the work contract (see later).Other reasons for such contract heterogeneity are changing legal requirements or regulations in collective contracts.Providing different contracts for the same job can also be a deliberate and voluntary choice of employers; the separate company Auto 5000 GmbH for up to 5000 employees that worked side-by-side with other VW employees with the much more attractive �“house contract�” founded in 2001.In general, the quickly growing share of temporary and contract staff is usually employed under completely different conditions than the rest of the workers of a company.




The market:Contract offersContinuous one-sided offer market for 180 sec. (15 periods).Employers can make as many offers they want.Public offer and private offers possible; contracts are only for

one period.An offer containsA wage level 0 w 100 and a desired non-binding effort.

As soon as 3 contracts of the same employer are accepted, the remaining offers of this employer are deleted.4 employers (principals); 16 employees (agents); i.e. an excessive supply of 4 workers. Unemployment benefit.




YZ

Z1 Y

1. Public offer

ZX Y




ZX YCA BLJ K

FD ECA GLX R

CA G



Rel. contracts �– St. Theory

Prediction 1: Risk-neutral principals should employ all their agents under identical contracts in the first period of the IC treatment. Thus, there should not be any difference between IC and UC in the first period.Prediction 2: If decision-makers are payoff-maximizers and this is common knowledge, Prediction 1 extends to the entire interaction horizon. Under more general preferences or without the assumption of common knowledge, however, heterogeneous contracts within the firm could be part of an equilibrium strategy in the IC treatment.Prediction 3: Principals in IC should fare at least as good as principals in UC.



Rel. contracts - Results

Wages



Rel. contracts - Results

Effort levels



Rel. contracts �– Interpret.

What happens?Principals almost never offer identical contracts to a priori identical agents if they are allowed to differentiate individually.

However, the introduction of our (rather weak) institution of uniform (standardized) contracts within firms has a significant and economically relevant effect on market parameters. It increases average wages, average effort levels and, therefore, market efficiency significantly.



Rel. contracts �– Interpret.

What happens?

Hence, we partly corroborate the fair uniform wage hypothesis. It seems that Akerlof (1982) was correct in adding a social component to his description of gift exchange when it comes to efficiency.

Agents do not become more reciprocal. The efficiency-enhancing effect is the consequence of a tendency of principals to over-differentiate contracts within their firm �– if they are allowed to �– compared to the social optimum.



Co-employment

Co-employment,tenure of contracts, and reciprocity

(with Vera Angelova and Werner Güth)

MotivationPaper IPaper II

Paper III


Co-employment

One-shot interaction and repeated interaction often co-exist in the real world. Examples

�• Workers that work alongside each other with different contracts (at

universities: tenured and untenured staff; in companies: regular workers

and leased laborers).

�• Provision units of public goods (people that live at the same place for a

long time and people that move a lot; clubs with different kinds of

members).

�• Work teams consisting of short-term and long-term members.

�• Sport teams with members that have contracts with different term

structures.


Paper III


Co-employment

Do principals discriminate between permanently and temporarily employed agents?How large is the extent of discrimination? How do agents react to such discrimination in terms of reciprocity?What are the characteristics of the behaviorally optimal contract with co-employment?What is the effect of co-employment on labor market efficiency?What are the effects of a non-discrimination clause on the efficiency of the labor market?What are the effects of information regarding co-worker contracts on reciprocity?


Paper III


We follow a stripped-down version of Brown, Falk and Fehr (2004) without an explicit labor market.Hence, we vary the important variables exogenously to make identification of effects easier �– the strength of an experiment.Each period with N = 10 and T = 20 consists of two stages after matching of principals and agents(i) Principals offer contracts {w, }, where w denotes the transfer or wage rate and the desired effort level. Wage w has to be an integer from the interval [1, 100]. Offers cannot be declined. (ii) Agents exert costly effort e out of the set of feasible effort levels [1,2,�….,10]. The desired effort level of the principal is not binding.The duration of a contract is always one period.

Co-employment

TNt ,...,... ,2 ,1

e~e~


Paper III


With money-maximizing decision makers:Two-stage game with complete information (backward induction).No agent has an incentive to provide more than the minimal level of effort, because a higher effort is costly.Principals offer each agent a wage equal to the outside option if this is profitable.There is a considerable efficiency loss.The solution holds in a repeated game setting; in addition, one needs to assume common knowledge of money-maximizing behavior.

Co-employment - Theory


Paper III


With other-regarding decision makers:E.g., with a Fehr and Schmidt (1999) model; not fully spelled out here (deriving point-predictions in multiple-agent settings depends strongly on assumptions regarding reference groups).Note that neither opportunistic, nor inequity-averse players should be affected by the interaction horizon.More interesting types of players are those who behave reciprocally out of strategic motives. It is easy to show that opportunistic agents initially have an incentive to mimic fair agents, when the proportion of fair principals is large enough in the population until the (second to) last period of a repeated interaction.



Paper III


With other-regarding decision makers:In the role of temporary agents such strategic cooperators would behave completely selfishly, whereas in the role of permanent agents they would act reciprocally.Consequently, fair-minded and opportunistic principals may offer generous contracts.In order to be an equilibrium such a strategy combination requires a certain number of fair-minded and strategic agents.If principals assume that the extent of fair-mindedness of agents is small enough (so that most agents will not react negatively to discrimination), strategic principals may offer different contracts to the two agents.Non-selfish preferences in the population leads to discrimination!



Paper III


Treatments:PP no info (a principal employs two agents in a partner design; they stay together for 10 periods with an announced second part with a surprise restart with re-shuffling for another 10 periods)TT no info (a principal employs two agents in a stranger design; re-shuffling every period with matching groups of 15; again re-start after 10 periods)PT no info (a principal employs two agents, one for 10 periods, one is replaced every period; restart after 10 periods, i.e. a new match of P and the principal)PT info (the same as PS no info, but BEFORE effort exertion, both agents receive info on the wage/desired effort levels going to themselves and to the other agent in the firm)PT no discrimination (the same as PS, but the principal can only offer the same contracts to the two agents)

Co-employment


Paper III


Co-employment - Results

050

050

0 5 10 15 20

0 5 10 15 20 0 5 10 15 20

PPnoinfo PTinfo PTnodiscrim

PTnoinfo TTnoinfo

(mean) wage P (mean) wage T

Period


Paper III


We implement an experiment that allows to study the effects of social comparison on reciprocity (and interaction effects with information provision and a non-discrimination clause).

The most straightforward application is firms whose employees have a different term structure of contracts.

Indeed, the co-existence of a temporary worker and a permanent worker leads to significant discrimination.

Co-employm. �– Interpret.


Paper III


The discrimination is a clear consequence of the incentive for opportunistic agents to mimic reciprocal ones in repeated interaction.

A non-discrimination clause does not help temporary workers, but it hurts permanent workers and reduces efficiency.

Providing information helps reducing discrimination, but it does not improve efficiency.



Paper III


Angelova, Güth and Kocher (2011b):Principals discriminate between the two types of agents also with partly complete contracts.Making contracts of co-workers public within firms before effort determination leads to more equal treatment of agents.Temporary agents react to unfair treatment by principals. They �“punish�” principals for being discriminated, on average, and �“reward�” principals for equal treatment in piece rate wages.Discrimination between permanent and temporary agents, on average, leads to a reduction of principals�’ profits in the treatment with disclosure, everything else equal.The fixed wage rather than the piece rate is the contract component by which principals trigger reciprocity (voluntary cooperation in excess of the enforceable level).



Paper III


Thanks very much for the attentionand the invitation!

MotivationModelExperimental DesignResults

26 October 2011

Psychological pressure in competitive environments: New evidence from a randomized

natural experiment

(with Mark Lenz and Matthias Sutter)

MotivationPaper IPaper IIPaper IIIPsych. pressure

26 October 2011

Psych. pr. �– Recent res.

The main result of Apesteguia and Palacios-Huerta (2010) is that there is a significant first mover advantage: In 60.5% the first-kicking team wins the shootout. However, their result is based on only 129 shootouts.

Economic application: A shootout is a sequential tournament with interim information provision (such as promotion

tournaments).

One explanation for the result is that the first-kicking team is likely to put psychological pressure on the second-kicking team.

We decided to give the question a second look and extended the data set considerably.


26 October 2011

Psych. pr. �– Our data

Tournament Number of shootouts in tournament

Shootouts with order of kicks

known

First-kicking team wins (rel.

frequency)

p-value(two-sided

Binomial test)

[1] World Cup 16 16 0.438 0.80

[2] European Championship 9 9 0.333 0.51

[3] Copa America (South America) 12 12 0.667 0.39

[4] African Nations Cup 17 13 0.692 0.27

[5] Gold Cup (Northern and Middle America)

5 5 0.400 1.00

[6] Asian Cup 10 8 0.375 0.73

[7] European Champions League* 28 28 0.643 0.19

[8] UEFA-Cup�‡ 76 74 0.527 0.73

[9] German Cups (DFB-Pokal, Ligapokal)

123 122 0.500 1.00

[10] English Cups (FA-Cup, League Cup, Charity Shield)

133 122 0.500 1.00

[11] Spanish Cup (Copa del Rey) 280 131 0.580 0.08

Sum [1] to [11] 709 540 0.531 0.16


26 October 2011

Psych. pr. �– Our results

Table2: Probit-regression. Team wins shootout as dependent variable (=1)

(1) (2) Constant Coefficient -0.0790 -0.1322* Standard error (0.0540) (0.0762) p-value (0.144) (0.083) Team kicks first Coefficient 0.1580 0.1493 Standard error (0.1081) (0.1085) p-value (0.144) (0.169) Home field Coefficient - 0.1151 Standard error - (0.1163) p-value - (0.322) Neutral field Coefficient - 0.0576 Standard error - (0.0581) p-value - (0.322) N (teams) 1080 1080 Adjusted R² 0.0029 0.0042 Log-likelihood -746.46 -745.48 Notes: ***, **, * denote significance at the 1%, 5%, 10% level, robust standard errors in parentheses (clustering at the level of the shootout-ID).


26 October 2011

Psych. pr. �– Our result


26 October 2011

Psych. pr. �– Why diff.?

The only explanation for the different results: biased sampleselection.

We calculate the probability with which one would get at least 60.5% of first-kicking teams winning in a sample of 129 shootouts if one sampled randomly from our sample of 540 shootouts. Since our dataset is a strict superset of APH�’s

dataset, this is equivalent to asking the question of how likely it is to get their results under the assumption that our data were considered the true population of shootouts from which APH sampled. This likelihood is only p = 0.03.


26 October 2011

If we imagine a scenario in which the true relative frequency offirst-kicking teams winning a shootout would be the one found in APH, i.e., 60.5% in the whole population of 709 shootouts. Under this assumption, we can calculate the probability with which one would get at most 53.1% of first-kicking teams winning in a subsample of 540 shootouts. This probability isp = 6.7*10-14.

MotivationPaper IPaper IIPaper IIIPsych. pr. �– Why diff.?


Fair employment hyp.

The fair employment hypothesis

(with Sebastian Strasser)




We extend the well-known fair wage-effort hypothesis to situations in which firms suffer from negative productivity shocks and test experimentally whether a fair employment hypothesis exists.The fair employment hypothesis stipulates that firms employ workers even if it is not profitable for them in the short run and refuse to use the threat of unemployment as a disciplining device in bad times (recessions).We start with a one-principal-one-agent environment and extend it.The main difference to the previous paper is that the productivity parameter varies over time.We also test signaling strategies over time.




More specifically= 10: in all periods: Good Times, GT, cf. BFF setting.= 5: in all periods: Bad Times, BT

depends (commonly known) on the period: Good and Bad

Times, GTBT, s.t.

Unemployment benefit = 6.




Set of treatments:

Theoretical predictions



Fair employm. - Results

Wages




Effort







Effort frequencies in boom phases

Effort frequencies in recession phases



Fair employm �– Interpret.

What explains the high employment levels across all treatments?

Not inequity aversion, but efficiency concerns à la Charness/Rabin (in line with the high employment in GTBT_RI), BUT reciprocity is higher in BT.Reputation building: To a certain extent, BUT employment is still very high in GTBT_RI.Wage flexibility: No. Employment is very high in GTBT_FIX. Wage stickiness does not seem to be a huge problem.Wage/effort signaling: To a certain extent, BUT employment is still very high in GTBT_RI.Employment as a kind signal: Promising explanation.



Fair employm �– 2 workers

Bewley (1999): layoffs of the least productive worker preferred to wage cuts in BT.Not possible to disentangle employment decision and wage policy in a single agent setting.Question: How do firms combine wage cuts and employment reductions when hit by a productivity shock?Control treatment with the possibility to hire two workers; lower marginal productivity of the second worker, both in GT and in BTRecessions in multi-worker firms (flexible wages)Main Result: Firms ration jobs already in booms but especially in recessions, identical wage effort patterns.Recessions in multi-worker firms (rigid wages)Main Result: Employment decline is amplified through wage rigidity.


Documents

Behavioral contracting: Optimale Verträge auf Arbeitsmärkten