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Self Selection and market power in risk sharing contracts

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  • Prasad, Kislaya
  • Salmon, Timothy C.

Abstract

Although the theory of optimal contracts and the principal agent model are now well established in the literature, empirical support for this theory has been mixed at best. We use economic experiments to test contract theory and assess the empirical relevance of two possible confounding factors that may explain why the theory has not received stronger empirical support. First, parameters of interest may be biased if agents self-select into projects with differing risk profiles based on risk preferences. Second, differing levels of market power on either side of the market could shift contract terms in ways contrary to theoretical predictions. In general, we find support for classical contract theory augmented to accommodate market power and self-selection based on risk preferences. We also find evidence for a third confound in the form of the characteristics of agents not party to the transaction affecting the terms of the contract.

Suggested Citation

  • Prasad, Kislaya & Salmon, Timothy C., 2013. "Self Selection and market power in risk sharing contracts," Journal of Economic Behavior & Organization, Elsevier, vol. 90(C), pages 71-86.
    • Handle: RePEc:eee:jeborg:v:90:y:2013:i:c:p:71-86
    DOI: 10.1016/j.jebo.2013.03.007
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    Cited by:

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    2. Sarah Jacobson & Ragan Petrie, 2009. "Learning from mistakes: What do inconsistent choices over risk tell us?," Journal of Risk and Uncertainty, Springer, vol. 38(2), pages 143-158, April.
    3. Golo-Friedrich Bauermeister & Oliver Mußhoff, 2019. "Multiple switching behaviour in different display formats of multiple price lists," Applied Economics Letters, Taylor & Francis Journals, vol. 26(1), pages 58-63, January.
    4. Dohmen, Thomas & Non, Arjan & Stolp, Tom, 2021. "Reference points and the tradeoff between risk and incentives," Journal of Economic Behavior & Organization, Elsevier, vol. 192(C), pages 813-831.
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    7. Hernán Bejarano & Francisco Galarza, 2016. "Can cognitive skills and risk aversion explain inconsistent choices? An experiment," Working Papers 16-03, Centro de Investigación, Universidad del Pacífico.

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    More about this item

    Keywords

    Incentive contracts; Principal–agent model; Self-selection; Market power; Experiments;
    All these keywords.

    JEL classification:

    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • C90 - Mathematical and Quantitative Methods - - Design of Experiments - - - General

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