An informational cascade occurs when it is optimal for an individual, having observed the actions of those ahead of him, to follow the behavior of the preceding individual without regard to his own information. We argue that localized conformity of behavior and the fragility of mass behaviors can be explained by informational cascades.

https://papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID1405027_code2024.pdf?abstractid=1286306&mirid=1&type=2

A Theory of Fads, Fashion, Custom, and Cultural Change as Informational Cascades

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I NCENTIVES ARE the essence of economics. Despite many wide-ranging claims about their supposed importance, there has been little empirical assessment of incentive provision for workers. The purpose of this paper is to critically overview existing work on the provision of incentives. Since the interests of workers and their employers are not always aligned, a large theoretical literature has emphasized how firms design compensation contracts to induce employees to operate in the firm's interest. This literature has reached into many areas of compensation and has pointed to a multitude of different mechanisms that can be used to induce workers to act in the interests of their employers. These include piece rates, options, discretionary bonuses, promotions, profit sharing, efficiency wages, deferred compensation, and so on. My objective here is to evaluate this literature in the light of a growing empirical literature on compensation. Where possible, I will address the literature from two perspectives. First, an underlying assumption of this literature is that individuals respond to contracts that reward performance. Accordingly, I consider whether agents behave in this way, and whether these responses are always in the firm's interest. Second, I address whether firms write contracts with these responses in mind. In other words, do contracts look like the predictions of the theory? Incentives are provided to workers

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The Provision of Incentives in Firms

Corruption has its adverse effects not just on static efficiency but also on investment and growth. This chapter discusses the reasons for the persistence of corruption that have to do with frequency-dependent equilibria or intertemporal externalities. There are many cases where corruption is mutually beneficial between the official and his client, so neither the briber nor the bribee has an incentive to report or protest, for example, when a customs officer lets contraband through, or a tax auditor purposely overlooks a case of tax evasion, and so on. The idea of multiple equilibria in the incidence of corruption is salient in some of the recent economic theorists' explanations. There is a strand in the corruption literature, contributed both by economists and non-economists, suggesting that, in the context of pervasive and cumbersome regulations in developing countries, corruption may actually improve efficiency and help growth.

Corruption and Development: A Review of Issues

Economics has much to do with incentives--not least, incentives to work hard, to produce quality products, to study, to invest, and to save. Although Adam Smith amply confirmed this more than two hundred years ago in his analysis of sharecropping contracts, only in recent decades has a theory begun to emerge to place the topic at the heart of economic thinking. In this book, Jean-Jacques Laffont and David Martimort present the most thorough yet accessible introduction to incentives theory to date. Central to this theory is a simple question as pivotal to modern-day management as it is to economics research: What makes people act in a particular way in an economic or business situation? In seeking an answer, the authors provide the methodological tools to design institutions that can ensure good incentives for economic agents. This book focuses on the principal-agent model, the "simple" situation where a principal, or company, delegates a task to a single agent through a contract--the essence of management and contract theory. How does the owner or manager of a firm align the objectives of its various members to maximize profits? Following a brief historical overview showing how the problem of incentives has come to the fore in the past two centuries, the authors devote the bulk of their work to exploring principal-agent models and various extensions thereof in light of three types of information problems: adverse selection, moral hazard, and non-verifiability. Offering an unprecedented look at a subject vital to industrial organization, labor economics, and behavioral economics, this book is set to become the definitive resource for students, researchers, and others who might find themselves pondering what contracts, and the incentives they embody, are really all about.

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The Theory of Incentives: The Principal-Agent Model

135 Despite the importance of this issue, not much systematic research appears to have been devoted to assessing the relative susceptibility of national and local governments to interestgroup capture. Here we describe a model of two-party electoral competition with “probabilistic” voting behavior and lobbying by specialinterest groups based on David Baron (1994) and Gene Grossman and Elhanan Helpman (1996) that helps identify determinants of relative capture at different levels of government. These include relative levels of voter awareness and interest-group cohesiveness, electoral uncertainty, electoral competition, heterogeneity of districts with respect to inequality, and the electoral system. While some of these uphold the traditional Madisonian presumption, others are likely to create a tendency for lower capture at the local level, so the net effect is theoretically ambiguous. This suggests that the extent of relative capture may be context-specific and needs to be assessed empirically.

Capture and Governance at Local and National Levels

Optimal Auditing, Insurance, and Redistribution

The authors study the optimal compensation policy for a corruptible inspector charged with monitoring pollution from a factory. Their utilitarian approach focuses on the trade-off among corruption, pollution, and enforcement effort. Owing to the strategic interaction between factory and inspector, changes in compensation policy have surprising effects, e.g., raising the penalty for corruption may cause pollution to increase. The authors find that bribery is an inefficient way of encouraging the inspector to monitor; society should wipe out corruption. Copyright 1995 by Royal Economic Society.

Corruptible Law Enforcers: How Should They Be Compensated?

Many developing countries are experimenting with decentralisation of public service delivery to elected local governments instead of bureaucrats appointed by a central government. We study the resulting implications in a theoretical model in which the central government is uninformed about local need and unable to monitor service allocations. Bureaucrats charge bribes for services as monopoly providers, resulting in underprovision of services, especially for the poor. Local governments are directly responsive to their citizens needs but may be subject to capture by elites. Effects of decentralisation on service volumes, efficiency and equity are analysed under different financing arrangements for local governments. The theme of the 2004 World Development Report is summarised by its opening paragraph: Too often, services fail poor people ‐ in access, in quantity, in quality. But the fact that there are strong examples where services do work means governments and citizens can do better. How? By putting poor people at the center of service provision: by enabling them to monitor and discipline service providers, by amplifying their voice in policymaking, and by strengthening the incentives for providers to serve the poor. Problems of accountability associated with traditional modes of delivery involving centralised bureaucracies include cost padding, service diversion, limited responsiveness to local needs, limited access and high prices charged especially to the poor. 1 Many developing countries have thus begun to experiment with initiatives to increase accountability of service providers by providing greater control rights to citizen groups. These include decentralisation of service delivery to local governments, community participation, direct transfers to households and contracting out delivery to private providers and NGOs. The programmes include a wide range of infrastructure services (water, sanitation, electricity, telecommunications, roads) and social services (education, health and welfare programmes). Countries where such trends have gathered

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Decentralisation and accountability in infrastructure delivery in developing countries

The Grossman-Hart principal-agent model of moral hazard is extended to the multiple agent case to explore the use of relative performance in optimal incentive contracting. Under the assumption that the principal chooses incentive schemes to implement agent actions as Nash equilibria, necessary and sufficient conditions are derived for the optimality of independent contracts, of rank-order tournaments, and for attainability of the first-best. In this context the relation of the principal's welfare to the correlation between the underlying randomness in outputs of different agents is also investigated. Finally, some problems with the Nash equilibrium implementation assumption are discussed. In this paper we extend the Grossman-Hart analysis of the principal agent problem to a multiple-agent setting. In this version of the problem, a risk-neutral principal is assumed to observe the output or a performance index for each (risk-averse) agent; the output of any agent depends on a privately observable action chosen by the agent and an exogenous random variable (the realization of which is not observed either by the principal, or by the agent before choosing its action). We especially focus attention on the role of relative performance evaluation in optimal incentive contracts, and the way this depends on properties of the underlying production technology and (the joint distribution of) the random variables affecting the outputs of different agents. In Section 2 of the paper we consider the principal's problem of finding an optimal incentive scheme and an action tuple for agents, subject to the constraint that the latter be implemented as a Nash equilibrium between agents by the chosen incentive scheme (where agents must attain at least their reservation utilities). A characterization of optimal incentive schemes is derived, analogous to the Grossman-Hart characterization for the single agent problem. This characterization is then utilized to find sufficient and (generically) necessary conditions for (a) optimal contracts for any agent to be independent of the performance of other agents, and (b) optimality of rank-order tournaments (where payments depend solely on ordinal comparisons of output across agents). We then describe a necessary and sufficient condition for the principal to extract maximum advantage from relative performance clauses, i.e. achieve the first-best level of expected utility in the multiagent situation. An implication of this result is that (under fairly weak conditions) perfect correlation in the underlying production uncertainties for different agents enables the principal to attain the first best if and only if sufficiently heavy penalties can be inflicted on agents. We then enquire what happens in intermediate cases of non-perfect correlation. It turns out that while in general the principal's welfare is a continuous function of the correlation coefficient, it is not always nondecreasing in the latter (because the correlation coefficient is not a general measure of association between two random variables, but rather a measure of linear association between them).

Dilip Mookherjee

Papers

Capture and Governance at Local and National Levels

Optimal Auditing, Insurance, and Redistribution

Corruptible Law Enforcers: How Should They Be Compensated?

Decentralisation and accountability in infrastructure delivery in developing countries

Optimal Incentive Schemes with Many Agents