Welfare, Incentives, Dynamics, and Equilibrium

ongoing

Informational frictions lead to inefficient allocations, reducing welfare. Dynamic incentive theory offers a powerful conceptual framework to analyse the optimal design of contracts and mechanisms mitigating these inefficiencies. Its technical difficulty and abstractness, however, have limited its applications. The objective of this project is to develop new frameworks to enhance the applicability of dynamic incentive theory and address important unanswered applied questions: 1) In corporate finance, I will evaluate the quantitative relevance of dynamic contract theory. To do so, I will develop a new structural econometric framework and estimate the magnitude of dynamic incentive problems and their consequences for corporate investment and bankruptcy risk. 2) In organization theory, I will study if equilibrium choices lead to excessive complexity. I will model the link between complexity and incentives. Then, in contrast with standard dynamic contract theory, which takes the tasks of agents as given, I will endogenize agents’ tasks and their complexity. Finally I will confront this theory to new data on complexity. 3) In asset pricing, I will build a novel equilibrium framework to study the consequences of dynamic incentive constraints for relative prices and the cross section of expected returns. In addition to this positive analysis, I will delineate the normative implications of the theory for financial markets regulation. 4) In public finance, I will study whether financial transactions should be taxed. To do so, I will extend the dynamic mechanism design paradigm of “new public finance” to financial transaction taxes and compare the distortions induced by these taxes with those induced by taxes on capital or labour income. By delivering useful results on four important issues, this project will demonstrate the applicability of dynamic incentive theory. To do so it will develop novel tools by combining dynamic incentive theory with other methodologies.