Essays in Industrial Organization and Behavioral Economics

Abstract

Next to the orthodox theories on contract design and optimal selling strategies, there is a recent and growing literature investigating how rational firms respond to consumer or employee biases. During the last decade the field of economics that modifies the “standard preferences” by incorporating findings from psychological research has made a significant progress. Now, there exist reasonable and tractable frameworks for modeling agents with reference-dependent preferences, time-inconsistent discounting, fairness concerns and many other behavioral motives. These “workhorse” models not only allow to investigate the “old” questions for a richer class of the agent's preferences, they also raise new questions. In three of the four main chapters of this dissertation, I follow this new “behavioral'“ approach and investigate contractual situations by allowing for biased consumers or employees to provide possible explanations for observed contractual arrangements that are puzzling from the perspective of standard orthodox economics. <br /> Chapter I, which is based on a joint project with Daniel Müller and Philipp Weinschenk, analyzes the well-known principal-agent problem with hidden actions. The principal can make the compensation payment of the agent depending on a performance measure which is imperfectly correlated with the agent's action choice. By making the compensation payment depending on performance, the principal can motivate the agent to provide a desired level of effort. By doing so, however, the principal imposes some risk on the agent since the performance measure is only a noisy signal of the agent's effort choice. Since human beings typically dislike to be confronted with risky situations, the principal faces a tradeoff between providing incentives and optimal risk sharing. The main finding is that a simple (lump-sum) bonus contract is optimal when loss aversion is the predominant determinant of the agent's risk preferences. If the employee's performance is below a certain threshold he receives only his base wage, whereas for performances above this threshold he receives the base wage plus a fixed performance independent bonus payment. This is in stark contrast to the finding for a “purely” risk averse agent who is not loss averse and thus exhibits local risk neutrality, which implies that paying slightly different wages for different signals improves incentives at negligible costs<br /> Chapter II, which is based on a joint paper with Daniel Müller, investigates the behavior and in particular the performance of a decision maker who faces self-control problems. We develop a model of continuous effort choice over time that shifts the focus from completion of to performance on a single task. In contrast to the existing literature on procrastination, we find that being aware of the own self-control problems can reduce a person's performance as well as his overall well-being. Moreover, we show that being exposed to an interim deadline increases the performance as well as the overall well-being of a hyperbolic discounter, irrespectively of his awareness of own self-control problems. <br /> In Chapter III, which presents a non-behavioral model, I analyze the effect of a larger contract space on firms' decisions to produce differentiated products. Chapter III shows that firms may have incentives for quality differentiation even when consumers do not differ in their tastes for quality but differ in their preferences for quantity. It is shown that quality differentiation can relax competition when firms can offer two-part tariffs. If firms are restricted to linear pricing, however, quality differentiation does not relax competition. The novel contribution of this chapter to the theory of product differentiation is to identify differences in consumers' preferences for quantity as a reason for strategic quality differentiation by firms.<br /> Chapter IV investigates the widespread use of flat-rate tariffs. With a flat-rate tariff a consumer pays a fixed amount which is independent of his usage, the basic fee, to obtain unlimited access to a good or service. The main finding of this chapter is that in equilibrium firms offer a flat-rate tariff to those consumers whose degree of loss aversion compared to marginal costs exceeds a certain threshold. Consumers with a lower degree of loss aversion are assigned to a metered tariff, i.e., a two-part tariff with a strictly positive unit price.