• to explain the theoretical models of asymmetric information and contract theory covered in the course,
• to relate them to the cases and application fields discussed in class,
• and to apply the taught theories to real world contracting problems not yet discussed in class.
• The latter implies • pursuing mathematical calculations, • using diagrammatic representations, • as well as producing consistent verbal arguments.

The aim of the course is to give the students a comprehensive insight into Information Economics and Contract Theory and its applications.

The theories focus on situations with incomplete information. Two or more partners which want to trade or to start a joint venture do not have complete information of important characteristics of the other partner or about the other partner’s effort level. Often this implies asymmetric information.  That means one partner knows his own characteristics or effort level, but the other cannot observe these characteristics or the level of effort, but knows that he/she knows less than the other partner.  An example is the market for second-hand cars where the seller has a much better idea about the quality of the car due to his/her experience from driving it than a potential buyer. The same is true for the insurance market where insurance customers can often evaluate their life style or health situation or the level of their activities to reduce damages much better than the insurance company.  If an entrepreneur seeks finances from a bank or a venture capital fund, he/she knows most likely much more about the sustainability of the business idea than the bank or the fund managers. A CEO is also in a better position to evaluate his/her level or quality of effort than the board of directors or the shareholders of the firm.  A bus company that runs bus lines on behalf of a municipality is also better informed about its cost of running the lines than the municipality. This gives the company an advantage in the bargain with the municipality about the compensation it receives for providing its services. There are lots of examples of economic situations where asymmetric information is important and this course should help you in understanding which problems occur, for example, on second-hand car markets, insurance markets or in financing new businesses and by which contractual measures they can be reduced. Usually it is the less-informed partner who wants to secure him-/herself against being exploited by the more informed partner and how this can be done is also discussed in the course.

The course is split in two parts. The first two thirds of the lectures are centred around the main textbook on the economics of information and contract theory. Here you get an insight into models of asymmetric information (hidden information) and moral hazard (hidden action) as well as into signalling models and principle agent models. In the second part of the course (approximately one third of the lectures ) we will focus on specific applications of the theory chosen also with regard to the interests of the students in class. Application could be taken from corporate governance, the financing of new businesses, recruitment or the salaries of new employees, public or private procurement, the regulation of markets with imperfect competition, corporate finance, privatisation of public firms, income taxation, etc.

Inés Macho-Stadler and David Pérez-Castrillo: An Introduction to the Economics of Information – Incentives and Contracts, 2nd Edition, Oxford University Press, 2001

This main textbook is supplemented by articles and cases that illustrate the application of the theory. (In 2012 we covered for example favoritism and hierarchies in firms, in a field experiment and on the soccer field.)

Supporting Literature:

- A. Mas-Colell, M. D. Whinston and J. R. Green: Microeconomic Theory, Oxford University Press, 1995 (chs. 13-14) (mikroøkonomibog på mellemniveau)

- B. Salanié: The Economics of Contracts – A Primer, MIT Press, 1997

- P. Bolton and M. Dewatripont: Contract Theory, MIT Press, 2005