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How are resources allocated across different R&D areas (i.e., problems to be solved)? As a result of dynamic congestion externalities, the competitive market allocates excessive resources into those of high return, being those with higher private (and social) payoffs. Good problems are tackled too soon, and as a result the distribution of open research problems in the socially optimal solution stochastically dominates that of the competitive equilibrium. A severe form of rent dissipation occurs in the latter, where the total value of R&D activity equals the value of allocating all resources to the least valuable problem solved. Resulting losses can be substantial.\ud \ud

Why don't poor countries adopt more productive technologies? Is there a role for policies that coordinate technology adoption? To answer these questions, we develop a quantitative model that features complementarity in firms' technology adoption decisions: The gains from adoption are larger when more firms adopt. When this complementarity is strong, multiple equilibria and hence coordination failures are possible. More important, even without equilibrium multiplicity, the model elements responsible for the complementarity can substantially amplify the effect of distortions and policies. In what we call the Big Push region, the impact of idiosyncratic distortions is over three times larger than in models without such complementarity. This amplification enables our model to nearly fully account for the income gap between India and the US without coordination failures playing a role.

This paper considers the design of an optimal rating system, in a market with adverse selection. We address two critical questions about rating design: First, given a number of categories, what are the criteria for setting the boundaries between them? Second, what are the gains from increasing the number of categories? A rating system helps reallocate sales from lower- to higher-quality producers, thus mitigating the problem of adverse selection. We focus on two main sources of market heterogeneity that determine the extent and effect of this reallocation: the distribution of firm qualities and the responsiveness of sellers' supply to prices. We provide a simple characterization for the optimal rating system as the solution to a standard k-means clustering problem, and discuss its connection to supply elasticity and the skewness of firm qualities. Our results show that a simple two-tier rating can achieve a large share of full information surplus. Additionally, we characterize the conflicting interests of consumers and producers in the design of a rating system.

We propose a theory linking imperfect information to resource misallocation and hence to aggregate productivity and output. In our setup, firms look to a variety of noisy information sources when making input decisions. We devise a novel empirical strategy that uses a combination of firm-level production and stock market data to pin down the information structure in the economy. Even when only capital is chosen under imperfect information, applying this methodology to data from the United States, China, and India reveals substantial losses in productivity and output due to the informational friction. Our estimates for these losses range from 7% to 10% for productivity and 10% to 14% for output in China and India, and are smaller, though still significant, in the United States. Losses are substantially higher when labor decisions are also made under imperfect information. We find that firms turn primarily to internal sources for information; learning from financial markets contributes little, even in the United States.

This article studies optimal patents with respect to the timing of innovation disclosure. In a simple model, we identify forces that lead firms to either suboptimally patent too early or too late in equilibrium, and we determine conditions so that stronger patents induce earlier or later equilibrium disclosure. Then, by solving an infinite multistage patent game with a more explicit structure, we describe innovation growth, and derive detailed predictions that can be used for policy experiments. As an application, we calibrate our multistage game using summary statistics from the seeds breeding industry. We find that weaker patent rights may result in welfare gains of 46% relative to the status quo. The gains are achieved because weaker patents reduce competition, thus leading firms to postpone patenting.

This paper studies bidding dynamics where values and bidding opportunities follow an unrestricted joint Markov process, independent across agents. Bids cannot be retracted, as is frequently the case in auctions. Our main methodological contribution is that we construct a mapping from this general stochastic process into a distribution of values that is independent of the type of auction considered. The equilibria of a static auction with this distribution of values is used to characterize the equilibria of the dynamic auction, making this general class very tractable. As a result of the option of future rebidding, early bids are shaded and under mild conditions increase toward the end of the auction. Our results are consistent with repeated bidding and skewness of the time distribution of winning bids, two puzzling observations in dynamic auctions. As an application, we estimate the model by matching moments from eBay auctions.Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.

Preemption games are widely used to model economic problems such as patent races. We introduce private information into these games and allow for this information to stochastically change over time. This reflects, e.g. how R&D competitors improve their innovations over time and keep these innovations secret before patenting them. The analysis initially appears intractable because of the complexity of the equilibrium updating of beliefs on opponents' information. However, we demonstrate the existence of a class of equilibria and calculate these equilibria in closed form. We find that the expected durations in these equilibria are longer than when players' information is public but, in some cases, shorter than in the collusive outcome. Hence, R&D secrecy slows down innovation disclosure. Copyright 2011, Oxford University Press.

We study the problem of a firm that faces asymmetric information about the persistent productivity of its potential workers. In our framework, a worker's productivity is either assigned by nature at birth, or determined by an unobservable initial action of the worker that has persistent effects over time. We provide a characterization of the optimal dynamic compensation scheme that attracts only high productivity workers: consumption—regardless of time period—is ranked according to likelihood ratios of output histories, and the inverse of the marginal utility of consumption satisfies the martingale property derived in [Rogerson, William P., 1985. Repeated moral hazard. Econometrica 53 (1) 69–76]. However, in the case of i.i.d. output and square root utility we show that, contrary to the features of the optimal contract for a repeated moral hazard problem, the level and the variance of consumption are negatively correlated, due to the influence of early luck into future compensation. Moreover, in this example long-term inequality is lower under persistent private information.

Entrepreneurs bear substantial risk, but empirical evidence shows no sign of a positive premium. This paper develops a theory of endogenous entrepreneurial risk taking that explains why self-financed entrepreneurs may find it optimal to invest in risky projects offering no risk premium. Consistently with empiri cal evidence, the model predicts that poorer entrepreneurs are more likely to undertake risky projects. It also finds that incentives for risk taking are stronger when agents are impatient. (JEL G31, G32, L25, L26) Entrepreneurial activity is risky and poorly diversified. Most economic models would suggest that the high degree of entrepreneurial risk should be compensated by a significant premium in returns.1 Yet empirical evidence finds that the premium to entrepreneurial activity is surprisingly low,2 which raises the question of why people become entrepreneurs. A number of hypotheses have been offered to answer this question, mostly based on the idea that entrepreneurs have a different set of preferences or beliefs (e.g., risk tolerance or overoptimism). This paper provides an alternative theory of endogenous entrepreneurial risk taking that does not rely on individual heterogeneity of preferences or beliefs. We incorporate endogenous choice of entrepreneurial risk in a simple dynamic occupational choice model. A borrowing constrained agent chooses whether to be a worker or an entrepreneur. The occupational choice is discrete, in the sense that each activity requires full-time involvement. A worker receives fixed wage income, while an entrepreneur gets access to an entrepreneurial technology and decides how much to invest in it. Borrowing constraints induce endogenous sepa ration into different occupations: the rich, who have sufficient funds for investment, choose to be entrepreneurs, and the poor prefer to receive fixed pay by becoming workers. The indivisibility of occupational choice may create a nonconcavity in the agent's value function as a function of

We analyze the problem of eliminating an inefficient regulation, such as protection, in a dynamic model in which there is incomplete information and unanimous approval from all parties involved is necessary. Existing firms have heterogeneous cost, and efficiency requires some of them to shut down when the inefficient regulation is eliminated. The government can set up a revelation mechanism, giving subsidies and requiring firms to exit the market at a given time depending on the information collected. Under full commitment the optimal policy prescribes that some inefficient firms remain active and are subsidized. The optimal policy takes a simple form, with at most two times at which the firms are allowed to exit.

There is widespread evidence supporting the conjecture that borrowing constraints have important implications for firm growth and survival. In this paper we model a multiperiod borrowing/lending relationship with asymmetric information. We show that borrowing constraints emerge as a feature of the optimal long-term lending contract, and that such constraints relax as the value of the borrower's claim to future cash flows increases. We also show that the optimal contract has interesting implications for firm dynamics. In agreement with the empirical evidence, as age and size increase, mean and variance of growth decrease, and firm survival increases.

This paper presents a model of cumulative innovation in which firms are heterogeneous in their research ability. We study the optimal reward policy when the quality of the ideas and their subsequent development effort are private information. Monopoly power is a scarce resource to be allocated across innovators who arrive at various times. The optimal assignment of property rights must counterbalance the incentives of current and future innovators. The resulting mechanism resembles a menu of patents that have infinite duration and fixed scope. This optimal patent menu can be implemented with a simple buyout scheme: The innovator commits at the outset to a price ceiling at which he will sell his rights to a future inventor. When a larger fee is paid initially, a higher price ceiling is obtained. Any subsequent innovator must pay this price and purchase his own buyout fee contract. We relate this mechanism to the proposed compulsory licensing schemes.

This paper considers the question of tacit collusion in repeated auctions with independent private values and with limited public monitoring. McAfee and McMillan show that the extent of collusion is tied to the availability of transfers. Monetary transfers allow cartels to extract full surplus. A folk theorem proved by Fudenberg et al. (Econometrica 62 (1994) 997–1039) shows that transfers of future payoffs are almost as good if players are patient and communicate before auctions. We ask how the scope of collusion is affected if players dispense with explicit communication and their monitoring is limited. Collusion better than bid rotation is still feasible, but full surplus cannot be extracted. This constraint becomes less severe with more players and large cartels can become asymptotically efficient even with very limited monitoring.

Entry restrictions are a common form of regulation in markets and occupations, either as a means of limiting the size of a market or affecting the quality of products or services provided by it. This paper analyzes demand, cost and informational characteristics that affect the impact of this type of policies on the quality mix of products provided by an industry and the welfare of its consumers. Selective increases in the costs of entry such as licensing requirements and direct restrictions with competitive bidding for entry rights are considered. We analyze the effects of these policies on entry decisions and also the additional selection effects that are obtained when exit is allowed for and the rights to participate in an industry can be freely traded.

Firm heterogeneity and the allocation of resources across firms play a key role in determining aggregate productivity. Entry barriers and misallocation can substantially impact productivity, as evidenced in recent work. This article provides a unifying theoretical framework and a review of this literature.

We study the effect of downward wage rigidity in a dynamic model when wages are negotiated according to Nash bargaining. Downward rigidity causes a decrease in the worker’s expected utility. For the firms the effect is ambiguous. Publicado

This paper considers the design of an optimal unemployment insurance system. The problem is modeled as a repeated principalagent problem involving a risk‐averse agent‐the unemployed worker‐and a risk‐neutral principal, which cannot monitor the agent's search effort. The optimal long‐term contract subject to the associated incentive constraints is characterized. This contract involves a replacement ratio that decreases throughout the unemployment spell and a wage tax after reemployment that, under some mild regularity conditions, increases with the lenght of the unemployment spell. Some numerical results are presented that suggest that the gains from switching to this optimal unemployment insurance scheme could be quite large. The performance of this optimal contract is also compared to alternative liquidity provision mechanisms.

This paper develops a sequential random matching model of asset trading to analyze how the extent of information about an asset that is available in the market can affect its tradeability. Liquidity traders are rational agents with higher impatience, which make optimal intertemporal consumption decisions given the trading constraints. Information asymmetries result in unexecuted trades. Agents who want to consume relatively early optimally choose to exchange initial assets for new assets that have lower expected payoff but are more liquid in subsequent trading. These assets have a lower expected rate or return (i.e., a liquidity premium) and higher trading volume. Journal of Economic Literature Classification Numbers: D83, G11, G14.

This paper studies a competitive dynamic model with firm level uncertainty and derives implications for the distribution of firm values and Tobin's q. Allowing for entry and exit, the model determines endogenously the degree of selection. A consequence of this selection is that average industry q values are biased above one. As parameters describing the technology and firm level uncertainty are changed, the equilibrium distribution for q values changes. This comparative statics is developed in the paper.

The authors develop a model of vintage human capital in which each technology requires vintage-specific skills. They examine the properties of a stationary equilibrium for their economy. The stationary equilibrium is characterized by an endogenous distribution of skilled workers across vintages. The distribution is shown to be single-peaked. Under general conditions, there is a lag between the appearance of a technology and its peak usage, a phenomenon known as diffusion. An increase in the rate of exogenous technological change shifts the distribution of human capital to more recent vintages, thereby increasing the diffusion rate. Copyright 1991 by University of Chicago Press.

We study a multiperiod principal-agent problem with moral hazard in which effort is persistent: the agent is required to exert effort only in the initial period of the contract, and this effort determines the conditional distribution of output in the following periods. We provide a characterization of the optimal dynamic compensation scheme. As in a static moral hazard problem, consumption — regardless of time period — is ranked according to likelihood ratios of output histories. As in most dynamic models with asymmetric information, the inverse of the marginal utility of consumption satisfies the martingale property derived in Rogerson (1985). Under the assumption of i.i.d. output we show that (i) incentives are concentrated in the later periods of the contract, implying an increase of the variance of compensation over time; (ii) the cost of implementing high effort decreases when there is an increase in either the duration or the intensity of persistence (i.e., how long and how strongly effort affects the distribution of output, respectively); and (iii) under infinite duration the cost gets arbitrarily close to that of the first best.

This paper presents a model of cumulative innovation where firms are heterogeneous in their research ability. We study the optimal reward policy when the quality of the ideas and their subsequent development effort are private information. The optimal assignment of property rights must counterbalance the incentives of current and future innovators. The resulting mechanism resembles a menu of patents that have infinite duration and fixed scope, where the latter increases in the value of the idea. Finally, we provide a way to implement this patent menu by using a simple buyout scheme: The innovator commits at the outset to a price ceiling at which he will sell his rights to a future inventor. By paying a larger fee initially, a higher price ceiling is obtained. Any subsequent innovator must pay this price and purchase its own buyout fee contract.

We develop a general model of lending in the presence of endogenous borrowing constraints. Borrowing constraints arise because borrowers face limited liability and debt repayment cannot be perfectly enforced. In the model, the dynamics of debt are closely linked with the dynamics of borrowing constraints. In fact, borrowing constraints must satisfy a dynamic consistency requirement: The value of outstanding debt restricts current access to short term capital, but is itself determined by future access to credit. This dynamic consistency is not guaranteed in models of exogenous borrowing constraints, where the ability to raise short term capital is limited by some prespecified function of debt. We characterize the optimal default-free contract - which minimizes borrowing constraints at all histories - and derive implications for firm growth, survival, leverage, and debt maturity. The model is qualitatively consistent with stylized facts on the growth and survival of firms. Comparative statics with respect to technology and default constraints are derived.

Political principals typically use low-cost "fire-alarm" signals transmitted by the media, interest groups, and disaffected constituents to monitor the activities of regulatory agencies. We argue that regulatory decision-making is biased and inconsistent if the instruments of political oversight are simple and the information flows to the principal are coarse relative to the complexity of the regulatory environment.

In this paper we have developed a general model of borrowing constraints based on the idea of limited enforcement. I our model, borrowing constraints arise as part of the optimal borrowing and lending contract. Our model extends previous theories of borrowing and lending , such as Hart and Moore (1994) allowing for uncertainty and dynamic effects of the resulting credit constraints.