Solutions Manual to Accompany Contract Theory

Contract Theoryby Patrick Bolton and Mathias Dewatripont, a comprehensive textbook on contract theory suitable for use at the graduate and advanced undergraduate levels, covers the areas of agency theory, information economics, and organization theory and presents many applications in all areas of economics, especially labor economics, industrial organization, and corporate finance. The exercises at the end of the book not only review, chapter by chapter, the basic concepts introduced in the text but also explore additional ideas and applications based on teaching material accumulated over the years by the authors and other instructors of contract theory. The solutions manual to this essential text gives complete solutions to 27 of the 54 exercises in the text, allowing students to study and compare their answers and take greater advantage of this crucial part of the book. The solutions manual follows the structure of the text, grouping exercises by chapter. Chapters 2-6 cover such static bilateral contracting problems as screening, signaling, and moral hazard; chapters 7 and 8 treat multilateral contracting, including auctions, bilateral trade under private information, and multiagent moral hazard; chapters 9 and 10 explore problems of repeated bilateral contracting; and chapters 11-13 cover incomplete contracts, the theory of ownership and control, contracting with externalities, and common agency.

Arthur Campbell is a Ph.D. candidate in Economics at MIT.

Moshe Cohen is a Ph.D. candidate in Economics at MIT.

Florian Ederer is Assistant Professor in the Anderson School of Management, UCLA.

Johannes Spinnewijn is a Ph.D. candidate in Economics at MIT.

Preface	p. xi
Introduction	p. 1
Hidden Information, Screening	p. 3
Question 1	p. 3
Question 2	p. 3
Question 3	p. 4
Characterization of First-Best Solution	p. 4
Two Types	p. 5
Continuum of Types	p. 5
Question 4	p. 7
Question 5	p. 7
Entrepreneur's Utility	p. 8
First-Best Solution	p. 8
Second-Best Solution	p. 9
Binding Constraints	p. 10
Low-Type Allocation	p. 11
Full Screening Problem	p. 11
Discussion	p. 12
Competition	p. 12
Hidden Information, Signaling	p. 15
Question 6	p. 15
Question 7	p. 15
Question 8	p. 16
Both Types Invest	p. 16
Only Bad Firms Invest	p. 17
Wasteful Advertising	p. 17
Question 9	p. 18
No Costs of Financial Distress	p. 18
Costs of Financial Distress	p. 20
Hidden Action, Moral Hazard	p. 23
Question 10	p. 23
Randomizing Scheme Cannot Be Optimal	p. 23
Question 11	p. 24
Question 12	p. 24
Question 13	p. 25
CEO Compensation	p. 25
Comparison	p. 26
Question 14	p. 27
Question 15	p. 27
Self-Financing	p. 28
Debt-Financing	p. 28
Equity-Financing	p. 30
Question 16	p. 31
Posttakeover Value	p. 31
Bid Price	p. 32
Second Best Contract	p. 32
First Best Contract	p. 33
Disclosure of Private Information	p. 35
Question 17	p. 35
Question 18	p. 35
Ex-Post Payoffs	p. 36
Comparison of Disclosure Regimes	p. 37
Voluntary Disclosure	p. 38
Question 19	p. 38
Unique Optimal Contract	p. 38
Optimal Random Verification	p. 40
Optimal Contract with Risk Averse Entrepreneur	p. 41
Question 20	p. 41
Multidimensional Incentive Problems	p. 43
Question 21	p. 43
Question 22	p. 44
First-Best Outcome	p. 45
Linear Contracts	p. 45
Question 23	p. 47
First-Best Solution	p. 48
Evidence-Based Rewards	p. 53
Decision-Based Rewards	p. 54
Information Disclosure	p. 56
Question 24	p. 57
Bilateral Trading and Auctions	p. 59
Question 25	p. 59
Question 26	p. 60
IC and IR Constraints	p. 60
Efficient Trade	p. 61
Comparison with Myerson-Satterthwaite Theorem	p. 62
Question 27	p. 63
Question 28	p. 63
Question 29	p. 63
Expected Payoff	p. 64
Standard Auctions	p. 65
Optimal Auction	p. 66
Uniform Distribution	p. 66
Multiagent Moral Hazard and Collusion	p. 69
Question 30	p. 69
Attaining the First Best Under Risk Neutrality	p. 70
Risk Aversion	p. 71
Question 31	p. 72
Question 32	p. 73
Optimal Side Contract	p. 74
Restriction to Collusion-Proof Contracts	p. 75
Optimal Collusion-Proof Contract	p. 75
Collusion Impossible	p. 77
Question 33	p. 79
Dynamic Adverse Selection	p. 81
Question 34	p. 81
Question 35	p. 82
Full Commitment	p. 82
No Commitment	p. 84
Question 36	p. 84
Pure Adverse Selection	p. 85
Adverse Selection & Moral Hazard	p. 86
Question 37	p. 87
Dynamic Moral Hazard	p. 89
Question 38	p. 89
Question 39	p. 89
Debt Equals Cash Flow	p. 91
Relaxing the Constraint	p. 91
Optimal Values of Debt	p. 91
Random First-Period Cash Flow	p. 92
Known New Investment Return	p. 92
Need for Short-Term Risky Debt	p. 93
Question 40	p. 93
Characterization of Rational-Expectations Equilibrium	p. 94
First-Period Allocation	p. 95
Positive Return of Firm-Specific Project	p. 95
Incomplete Contracts	p. 99
Question 41	p. 99
Question 42	p. 100
First-Best Allocation of Assets and Investment Levels	p. 101
Optimal Asset Ownership	p. 101
Comparison	p. 103
Ex Post Bargaining with an Outside Option	p. 103
Question 43	p. 104
Question 44	p. 105
Feasibility Constraints	p. 106
Optimal Control Structures	p. 110
Comparison with Aghion & Bolton (1992)	p. 112
Unverifiable Information Contracting	p. 113
Question 45	p. 113
Question 46	p. 114
Question 47	p. 114
Question 48	p. 115
Question 49	p. 115
First-Best Solution	p. 116
No Initial Contract	p. 116
Single-Pair contract	p. 117
At-Will-Contracting Provision	p. 118
No Direct Externalities	p. 120
Question 50	p. 121
First-Best Outcome	p. 122
Null Contract with Renegotiation	p. 122
No Renegotiation	p. 123
Contracting with Renegotiation	p. 123
Discussion	p. 125
Question 51	p. 125
Aghion-Tirole with Quadratic Effort Costs	p. 125
Strong Conflict of Interest	p. 127
Random Choice of Project	p. 128
Markets and Contracts	p. 131
Question 52	p. 131
Observable and Contractible Action	p. 131
Unobservable or Non-Contractible Action	p. 132
Common Agency	p. 133
Question 53	p. 134
Question 54	p. 134
First-Best Solution	p. 135
Joint Contract	p. 135
Common Agency	p. 136
Comparison and Discussion	p. 137
Bibliography	p. 139
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Solutions Manual to Accompany Contract Theory

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