Essays on behavioral and dynamic contract

Abstract

This dissertation studies the design of prices or incentives in dynamic settings where customers are privately informed about their psychological biases, or agents are privately informed about the technology. Chapter 1 studies how firms set prices when their consumers have time-inconsistent preferences and naive beliefs. Temptation goods, such as credit card-financed con- sumption, are overvalued by consumers in the short run. It is typically assumed that a monopolistic firm maximizes profit by pricing temptation goods above marginal cost when consumer naivete is observable. However, market evidence contradicts this result. This chapter explains the puzzle by the assumption that consumer naivete is unobservable. Then it is optimal for a monopoly seller to offer a menu of options that have prices both above and below marginal cost. Chapter 2 studies a project manager deciding on workers’ workload assignments. Workers face productivity shocks over time. Workers also tend to procrastinate, although they prefer flexibility in production. Commitment of early production can overcome procrastination. The optimal compensation scheme depends on whether the manager’s objective is to maximize profit or welfare. It also depends on the degree of workers’ procrastination. When the worker is a serious procrastinator, it is optimal for a profit-maximizing manager to monitor midterm output according to a pass-fail criterion. The final chapter studies an investor deciding on resource allocation and manage- rial compensation. The manager privately observes time-varying project quality. A signal that contains information about the evolution of future quality is also privately available to the manager initially. When the manager reports a better initial signal, the investor allocates more resources to the project in every period. Growth of the project scale depends on how strongly the initial signal predicts future quality. How- ever, the project with a better initial signal may grow more slowly and distortions may persist indefinitely.