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in the Indiana Constructor
Foundations and Trends in Microeconomics, FORTHCOMING
(revised version: June 2008)ABSTRACTSeller reputation is an important asset because buyers often chooses sellers on the basis of their reputation. This is particularly true when the quality of the good or service transacted are hard to measure and the parties cannot perfectly contract on the outcome of the transaction. As a consequence, the seller will be mindful of building and maintaining a good reputation through the information that buyers have about the seller, including previous transactions and the reports of other buyers. We introduce a unifying framework that embeds a number of different approaches to seller reputation, incorporating both hidden information and hidden action. We use this framework to stress that the way in which consumers learn affects both behavior and outcomes. In particular, the extent to which information is generated and socially aggregated determines the efficiency of markets. After reviewing these theoretical building blocks we discuss several applications and empirical concerns. We highlight that the environment in which a transaction is embedded can help determine whether the transaction will occur and how parties will behave. Institutions, ranging from the design of online markets to norms in a community, can be understood as ensuring that concerns for reputation lead to more efficient outcomes. Similarly, the desire to affect consumer beliefs regarding the firm’s incentives can help us understand strategic firm decisions that seem unrelated to the particular transactions they wish to promote. We conclude by considering slightly different models of reputation that lie beyond the scope our framework, briefly reviewing the somewhat sparse empirical literature and highlighting and suggesting future directions for research.
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Journal of Industrial Economics, FORTHCOMING
(revised version: June 2008)ABSTRACTLocal governments can provide services with their own employees or by contracting with private or public sector providers. We develop a model of this “make-or-buy” choice that highlights the trade-off between productive efficiency and the costs of contract administration. We construct a dataset of service provision choices by U.S. cities and identify a range of service and city characteristics as significant determinants of contracting decisions. Our analysis suggests an important role for economic efficiency concerns, as well as politics, in contracting for government services. JEL codes: D23, D73, H11, L33.
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Journal of Law, Economics and Organization, FORTHCOMING
ABSTRACTShould the buyer of a customized good use competitive bidding or negotiation to select a contractor? To shed light on this question, we consider several possible determinants that may influence the choice of auctions versus negotiations. We then examine a comprehensive data set of private sector building contracts awarded in Northern California during the years 1995-2000. The analysis suggests a number of possible limitations to the use of auctions. Auctions may perform poorly when projects are complex, contractual design is incomplete and there are few available bidders. Furthermore, auctions may stifle communication between buyers and sellers, preventing the buyer from utilizing the contractor's expertise when designing the project. Some implications of these results for procurement in the public sector are discussed. JEL classifications: D23, D82, H57, L14, L22, L74.
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California Management Review 2007, 50(1):261-277
ABSTRACTFew recent business trends have received as much attention as the practices of outsourcing and offshoring. Many cases of failed outsourcing contracts suggest that the strategic use of outsourcing may not be as beneficial as some believed, and hidden costs are often cited as a main source of failure. A business leader can successfully innovate the sourcing practices of his organization by employing strategic frameworks that will anticipate the hidden costs of outsourcing. This article offers such a framework, and argues for its wide use.
Quarterly Journal of Economics 2005, 120(1):132-172
ABSTRACTWhen it is hard to assess product quality, firms will sub-optimally hire low ability workers. We show that organizing as a profit-sharing partnership can alleviate these problems. Our theory explains the historical prevalence of profit sharing in professional service industries such as law, accounting, medicine, investment banking, architecture, advertising, and consulting, and the relative scarcity of profit sharing in other industries. It also sheds light on features of partnerships such as up-or-out promotion systems, and on recent trends in professional service industries.( JEL codes: D20, D82, J33, J44, J54, L22.
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Economic Theory 2003, 21(2-3):635-651
ABSTRACTAn adverse selection model of firm reputation is developed in which short-lived clients purchase services from firms operated by overlapping generations of agents. A firm's only asset is its name, or reputation, and trade of names is not observed by clients. As a result, names are traded in all equilibria regardless of the economy's horizon, and the general equilibrium analysis links the value of a name to the market for services. This link causes a non-monotonicity that precludes higher types from sorting themselves through the market for names and leads to "sensible" dynamics: reputations, and name prices, increase after a success and decrease after a failure. (JEL C70, D80, L14)
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Journal of Political Economy August 2002, 92(2):854-882
ABSTRACTReputational career concern provide incentive for short lived agent to work hard, but it is well known that these incentive disappear as an agent reaches retirement. This paper investigates the effect of a market for firm reputation on the life-cycle incentives of firm owners to exert effort. A dynamic general equilibrium model with moral hazard and adverse selection generates two main results. First, incentives of young and old agents are quantitatively equal, implying that incentives are "ageless" with a market for reputations. Second, good reputations cannot act as effective sorting devices: in equilibrium, more able agent cannot outbid lesser ones in the market for good reputations. In addition, welfare analysis shows that social surplus can fall if clients observe trade in firm reputation. (JELC70, D82, L14, L15)
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American Economic Review Papers and Proceedings May 2002, 92(2):433-437
ABSTRACT
65 years ago, Ronald Coase (1937) asked what determines whether production will be organized in a firm or through the market, later coined the "make-or-buy" decision. This question was put center stage by Oliver Williamson (1975, 1985) who further developed Transaction Costs Economics(TCE), arguing that incomplete contracts and specific relationships overshadowed by opportunism, asymmetric information and bounded rationality, will lead vertical processes to integrate. Benjamin Klein et al. (1978) enhanced TCE with the "hold-up" problem: in the face of incomplete contracts, specificity and opportunistic behavior, integration can help promote ex ante investment incentives. Sanford Grossman and Oliver Hart (1986) (followed by Hart and John Moore (1990)) developed the Property Rights Theory (PRT) of the firm (See Hart, 1995). PRT formally model the hold-up problem, offered a precise definition of integration via ownership and residual control rights, and analyzed the costs and benefits of integration in a unified manner. However, PRT narrowed the focus of the make-or-buy question on one type of transaction cost - the hold up problem. This paper focuses attention on a different kind of transaction cost: haggling and friction due to ex post changes and adaptations when contracts are incomplete. The level of a transaction's complexity, which is associated with contractual incompleteness, will be the shifting parameter that determines both incentive schemes and integration decisions. This focus is motivated by a careful examination of procurement decisions in industry, and has strong empirical content since the exogenous shifter (complexity) seems easier to measure than specificity.
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RAND Journal of Economics Autumn 2001, 32(3):287-307
ABSTRACT
Inspired by facts from the private-sector construction industry, we develop a model that explains many stylized facts of procurement contracts. The buyer in our model incurs a cost of providing a comprehensive design and is faced with a tradeoff between providing incentives and reducing ex post transaction costs due to costly renegotiation. We show that cost-plus contracts are preferred to fixed-price contracts when a project is more complex. We briefly discuss how fixed-price or cost-plus contracts might be preferred to other incentive contracts. Finally, our model provides some microfoundations for ideas from Transaction Cost Economics.
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American Economic Review June 1999, 89(3):548-563
ABSTRACT
I develop a model in which a firm's only asset is its name, which summarizes its reputation, and study the economic forces that cause names to be valuable, tradeable assets. An adverse selection model in which shifts of ownership are not observable guarantees an active market for names with either finite or infinite horizons. No equilibrium exists in which only good types buy good names. The reputational dynamics that emerge from the model are more relistic than those in standard game-theoretic reputation models, and suggest that adverse selection plays a crutial role in understanding firm reputation.
Journal of Economic Theory 1996, 69(2):270-289
ABSTRACT
This paper extends the applications of the theory of social situations. In particular, we investigate characteristics of optimistic stable standards of behavior (OSSBs) in repeated extensive form games. The OSSB is interesting for two reasons: First, it refines subgame perfect equilibrium. Second, it strongly relates to von Neumann-Morgenstern abstract stable sets. We characterize the nondiscriminating OSSB, and derive a sufficient condition for the existence of a unique nondiscriminating OSSB - a condition that is independent of the discount factor, ë. Our main result shows that the nondiscriminating OSSB selects Pareto optimal subgame perfect equilibrium paths in a class of repeated games.