Essays in Applied Microeconomics and Management

Abstract

A first wave of contributions to the field of psychology and economics mainly consisted of pointing out problems with traditional economic assumptions and articulating alternatives. By now, research has evolved to what sometimes is referred to as “second-wave behavioral economics”: while standard economic questions are addressed with standard economic tools, analysis moves beyond the traditional set of assumptions and on to psychologically better grounded, more realistic assumptions. The first three chapters of my dissertation belong to this field of second-wave behavioral economics, providing possible explanations for observed contractual design or workplace arrangements that may seem puzzling from the perspective of orthodox economic theory. Chapter I, which is based on a joint paper with Fabian Herweg, investigates how interim deadlines affect behavior and 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 her 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 her awareness of own self-control problems. Chapter II, which is based on a joint project with Fabian Herweg and Philipp Weinschenk, re-examines the well-known principal-agent problem with moral hazard. By making the agent’s compensation payment depend on a performance measure which is imperfectly correlated with the agent's action choice, the principal can motivate the agent to provide a desired level of effort even though the agent’s action is unobservable. 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. With human beings typically displaying aversion to risky situations, the principal faces a tradeoff between providing incentives and optimal risk sharing. Under the orthodox notion of risk aversion the agent exhibits local risk neutrality, which implies that paying slightly different wages for different signals improves incentives at negligible costs. In consequence, the optimal contractual arrangement is predicted to make pay dependent on performance in a rather complex way, which is hard to reconcile with contractual form in observed practice. The main finding in this second chapter is that when expectation-based loss aversion is the predominant determinant of the agent's risk preferences, then the optimal contract takes the most basic form an incentive contract possibly can take: the form of a simple (lump-sum) bonus contract. This finding helps to mend, at least to some degree, the often lamented gap between theoretically predicted complexity of contractual arrangements under the orthodox notion of risk aversion on the one hand, and simplicity of observed contracts on the other hand. In Chapter III, I discuss a particular form of workplace design as a promising approach for organizations to cope with problems arising from their members being susceptible to confirmation bias. Confirmation bias refers to the unknowing and unintentional selectivity in the acquisition and use of evidence. In organizations there is ample opportunity for confirmation bias to adversely affect organizational performance, e.g. in the form of a distorted process of performance appraisal. With bad personnel decisions due to an unreliable process of performance appraisal being very costly for an organization, it is little surprising that organizations strive to find a way for coping with raters being susceptible to confirmation bias. In this chapter, I argue that the work practice of job rotation, which makes an employee switch divisions every now and then, and thereby regularly breaks up the matches between the evaluating supervisor and the employee to be evaluated, leads to a more reliable process of performance appraisal — a benefit which may well outweigh the costs usually associated with implementation of this particular form of workplace design. In Chapter IV, which presents a non-behavioral model and is based on a paper with Fabian Herweg, we analyze a formal model of third-degree price discrimination in input markets which allows for costly entry into the downstream industry. Price discrimination is found to foster entry in the sense that whenever entry occurs under uniform pricing, entry also occurs under a discriminatory pricing regime. If downstream firms operate in separate markets, whenever entry occurs under price discrimination but not under uniform pricing, social welfare is strictly higher under the discriminatory pricing regime because opening of a new market increases consumers' surplus and upstream profits, and also gives rise to nonnegative profits for the entering downstream firm. If downstream firms engage in competition, on the other hand, entry occurring under a discriminatory but not under a uniform pricing regime no longer is a sufficient condition for an increase in welfare. The reason is that price discrimination leads to an inefficient allocation of production shares which benefits the upstream supplier and consumers, but does not necessarily make society better off if the cost of entry or the increase in the cost of production is high. Thus, in the light of our findings which identify the welfare effects of third-degree price discrimination in input market as highly ambiguous, calls for a determinate legislature which either bans or permits discriminatory pricing practices seem inadequate.

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