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We study dominant strategy incentive compatibility in a mechanism design setting with contingent contracts where the payoff of each agent is observed by the principal and can be contracted upon. Our main focus is on the class of linear contracts (one of the most commonly used contingent contracts) which consist of a transfer and a flat rate of profit sharing. We characterize outcomes implementable by linear contracts and provide a foundation for them by showing that, in finite type spaces, every social choice function that can be implemented using a more general nonlinear contingent contract can also be implemented using a linear contract. We then qualitatively describe the set of implementable outcomes. We show that a general class of social welfare criteria can be implemented. This class contains social choice functions (such as the Rawlsian) which cannot be implemented using (uncontingent) transfers. Under additional conditions, we show that only social choice functions in this class are implementable.

We study the bilateral trading problem under private information. We characterize the range of possible mechanisms which satisfy ex-post efficiency, incentive compatibility, individual rationality, and budget balance. In particular, we show that the famous Myerson–Satterthwaite impossibility result no longer holds when contingent contracts are allowed.

In negotiations in which the potential value creation depends upon external uncertainties, and the players have different beliefs about these uncertainties, it is well known that contingent contracts can enable agreement. But by allowing contingent payments, each player’s expected value capture can, in some situations, be made arbitrarily large. This fact prompts two natural questions. Does the increase in the players’ expected value capture imply an increase in expected value creation? And is there a point at which the contract can become more about making a wager and less about exploiting differences to enable agreement? We address these questions by showing that a player’s expected value capture can be separated into two components: an expected share of ex post value creation and an expected transfer of value from one player to another. The latter can be represented by a zero-sum wager. We show that if contracts are restricted to be ex post individually rational—a natural condition implicit in Arrow ( 1953 ) and Raiffa (The art & science of negotiation, Harvard University Press, Cambridge, 1982 )—a joint increase in the players’ expected value captures can always be attributed to a division of ex post value creation that better exploits the players’ beliefs rather than to an increase in an embedded zero-sum wager.

Although previous research demonstrates the profitability of partial refund policies in a monopoly setting, there is a certain lack of ubiquity in practice about these refunds in competitive service markets. This raises the question of how a partial refund policy may work and whether it is even sustainable in a competitive environment. This study investigates how competition may influence the profitability and the equilibrium choice of refund policies. It is shown that partial refunds may endogenously change the nature of strategic interaction between service providers from local monopolies into a competition regime, which moderates the gains from exploiting the efficiency-enhancing effect of partial refunds. A whole range of pure-strategy equilibria can be obtained as a result of the interplay between the efficiency-improving and the competition-intensifying effects. When the capacity is small (large) such that the efficiency-improving (the competition-intensifying) effect is dominant, both firms in equilibrium follow identical partial (zero) refund policies. Moreover, interestingly, the symmetric firms may end up in an asymmetric equilibrium in which one firm follows a partial refund policy and the other adopts a zero refund policy.

We consider convertible bonds that contractually stipulate payment standstill, contingent on a market indicator of a sovereign’s credit worthiness breaching a distress threshold. This financial innovation limits the likelihood of debt crises and imposes risk sharing between creditors and the debtor. Drawing from literature on contingent contracts, neglected risks, and bank CoCo, we extend prevailing arguments in favor of sovereign CoCo (S-CoCo). We discuss issues relating to their design: which market trigger, market discipline and sovereign incentives, and errors of false alarms or missed crises, and provide supporting evidence with eurozone data and a simple simulation on the use of S-CoCo. We develop a risk management model using these instruments to trade off the expected cost for sovereign financing over a long horizon, with tail risk. The model shows how contingent bonds can improve a country’s debt risk profile. Using Greece as a case study the model illustrates improvements in expected cost vs. tail risk for the country when using contingent debt.

Purpose This study aims to conceive and develop a pricing model for the Ijara contingent convertible contract (ICCC, hereafter), considering the possibility that the lessee may default. The ICCC model grants the lessor the option of converting the unpaid amount into equity or recovering the leased equipment and selling it at market price in case of financial distress. Design/methodology/approach The ICCC is consistent with the profit-sharing approach and the new risk management techniques, which are compatible with Islamic philosophy. Relying on real options theory and the contingent claim approach, a closed-form solution of the firm’s assets is developed in a dynamic environment, where the rate of return is generated by a Cox-Ingersoll-Ross stochastic process. Findings Examining the numerical analysis reveals the impact of the firm value, the conversion or sell decision and the conversion ratio and volatility on the ICCC value. The value of the ICCC can increase substantially as the value of the firm approaches the conversion threshold. The conversion ratio as well as the asset market price play equally an important role in the decision to convert or sell. Originality/value This paper develops a pricing model for a contingent Ijara contract, which incorporates a conversion option to mitigate the lessee’s credit risk during periods of economic instability. The ICCC is a cooperative strategy that would be advantageous to all parties, including the lessor and lessee. In the event of a conversion, businesses may be able to continue operating thanks to this financial innovation, and the lessor may profit from the company’s recovery by freeing up more resources for the use of more profitable ventures.

We describe a pricing structure for the provision of IT services that ensures trust without requiring repeated interactions between service providers and users. It does so by offering a pricing structure that elicits truthful reporting of QoS by providers while making them profitable. This mechanism also induces truth-telling on the part of users reserving the service. [PUBLICATION ABSTRACT]

Three species of salmon in the Snake River Basin have been listed as endangered.Recovery efforts for these fish include attempts to obtain increased quantities of water during smolt migration periods to improve habitat in the lower basin.Agriculture is the dominant user of surface flows in this region. This study investigates farmer cost of a contingent water contract requiring the agricultural release of stored irrigation supplies in low flow years during critical flow periods.Results show that contingent contracts can provide substantial quantities of water at a relatively modest cost without significantly affecting the agricultural base of the area.

We develop a theory that shows signaling a firm’s fundamental quality (e.g., its operational capabilities) to lenders through inventory transactions to be more efficient—it leads to less costly operational distortions—than signaling through loan requests, and we characterize how the efficiency gains depend on firm operational characteristics, such as operating costs, market size, and inventory salvage value. Signaling through inventory being only tenable when inventory transactions are verifiable at low enough cost, we then turn our attention to how this verifiability can be achieved in practice and argue that blockchain technology could enable it more efficiently than traditional monitoring mechanisms. To demonstrate, we develop b_verify, an open-source blockchain protocol that leverages Bitcoin to provide supply chain transparency at scale and in a cost-effective way. The paper identifies an important benefit of blockchain adoption—by opening a window of transparency into a firm’s supply chain, blockchain technology furnishes the ability to secure favorable financing terms at lower signaling costs. Furthermore, the analysis of the preferred signaling mode sheds light on what types of firms or supply chains would stand to benefit the most from this use of blockchain technology. This paper was accepted by Victor Martínez-de-Albéniz, operations management .