Narrow networks in Obamacare

by on October 18, 2016 at 1:33 pm in Economics, Law, Medicine | Permalink

That’s why the results of a recent study of new plans offered in California are especially troubling. Simon Haeder, a West Virginia University political scientist, and colleagues at the University of Wisconsin-Madison and the University of California, Irvine, found that access to primary care physicians was relatively poor for a sample of plans offered through California’s Affordable Care Act Marketplace in 2015. Most Obamacare marketplace plans in California, as well as in other states, are narrow network plans.

Using a “secret shopper” approach, the study found that only about 30 percent of attempts for appointments with specific primary care doctors were successful. In this approach, an individual pretending to be a patient seeking an appointment called the offices of over 700 primary care doctors listed in marketplace plan directories.

In about 15 percent of cases, the doctor did not accept the caller’s plan, despite being listed in its directory. In nearly 20 percent of cases, the directory included the wrong phone number or the number was busy in two calls on consecutive days. Ten percent of doctors called were not accepting new patients. And about 30 percent of doctors called were not primary care physicians, despite being listed as such in the directory.

When callers were able to make an appointment, the average waiting time for a physical exam was about three weeks. In cases for which the caller pretended to have acute symptoms, the average time until an appointment was about one and a half weeks.

That is from Austin Frakt (NYT).  It seems to be an example of the kind of rationing many of us predicted for Obamacare, although I would like to see the comparable numbers for the pre-ACA years.  The piece has other points of interest, mostly about cost savings, which seem to be real.

Overall, our results suggest that investing in secure payments infrastructure can significantly enhance “state capacity” to implement welfare programs in developing countries.

That is from Muralidharan, Niehaus, and Sukhtankar in the latest American Economic Review.  Their main result is this:

We find that, while incompletely implemented, the new system delivered a faster, more predictable, and less corrupt NREGS payments process without adversely affecting program access.

Most of all there is lower leakage of benefits, and program participants strongly prefer the biometric arrangements and the accompanying direct cash transfers.  The measurements of this paper, by the way, are based on 19 million data points.

I believe the Indian biometric smartcard initiative remains under-discussed and underappreciated.  It is actually one of the greatest achievements of contemporary times, based upon the innovative mobilization of the labor of millions in a manner that probably only India could do and that at first sounded quite ridiculous.  Scan, record, and use the biometric information of over a billion people, and in a “backward” country at that.  Well, they haven’t finished but it is well on track to succeed.

I do worry about the privacy implications of the technology and the data collection, but as it stands today so many Indians don’t have that much privacy in any case.

Here are ungated versions of the paper.  Here is my earlier post on the paper and the technology.  I had written:

One broader lesson here is that developing nations are not merely copying and applying the inventions of the West, but innovating on their own.  But a lot of their innovations take labor-intensive rather than capital-intensive forms, and thus they do not always look like innovations to our sometimes ethnocentric eyes.

Still true.

The founding father of Singapore, Lee Kuan Yew, credits ‘social discipline’ for the phenomenal economic rise of his country (Sen, 1999). Countries such as Singapore apparently demonstrate that autocratic measures are probably necessary, particularly in culturally fractionalized societies for creating the social stability necessary for economic growth (Colletta et al., 2001). Such thinking informs the so-called “Asian model” (Diamond, 2008).1 Recent studies, particularly in economics, support the logic (Alesina et al., 2006 and Easterly et al., 2006). According to these scholars, the more congruent territorial borders are with nationality, the better the chances for good economic policy to appear endogenously from within these societies because social cohesion determines good institutions and policies for development (Banerjee et al., 2005 and Easterly, 2006b). This paper addresses the question of whether or not social diversity hampers the adoption of sound economic policies, including institutions that promote property rights and the rule of law. We also examine whether democracy conditions diversity’s effect on sound economic management, defined as economic freedom, because the index of economic freedom is strongly associated with higher growth and is endorsed by proponents of the ‘diversity deficit’ argument (Easterly, 2006a).2

…Using several measures of diversity, we find that higher levels of ethno-linguistic and cultural fractionalization are conditioned positively on higher economic growth by an index of economic freedom, which is often heralded as a good measure of sound economic management. High diversity in turn is associated with higher levels of economic freedom. We do not find any evidence to suggest that high diversity hampers change towards greater economic freedom and institutions supporting liberal policies.

Paper here. The data is a panel from 116 countries covering 1980–2012 so this doesn’t rule out a negative long-run effect but it is prima facie evidence that diversity need not reduce freedom or growth.

That is a new paper by Bob Hall (you must scroll down to get to the pdf), here is the abstract:

Answer: Between 2007 and 2014, GDP growth was held back by shortfalls of
 4.4 percent in productivity
 4.0 percent in capital input
 3.6 percent in labor-force participation
 2.2 percent in growth of the working-age population

Any further questions you might have?

There are other interesting macro papers at the link, and hat tip goes to Greg Mankiw.

We find that the wage differential between formal/regulated and informal/unregulated sectors increased after 2008. Moreover, while wages in the informal sector decreased by about 20% in 2008-13, wages in the formal sector virtually did not fall. This is consistent with the view of a substantial downward stickiness of wages in the regulated labour market. Importantly, before the recession, wages in the formal and informal sectors moved in parallel (with a 15% premium in the formal sector) – confirming the validity of the parallel trends assumption essential for our difference-in-differences methodology, and showing that both regulated and unregulated labour markets have a similar degree of upward flexibility of wages.

We also look at the employment changes in the two sectors. We find that in 2008-2013, employment in the formal labour market fell by 16%. At the same time, employment in the informal labour market did not vary – if anything, it increased slightly (by 1.6%), although the change is not statistically significant. This finding is fully consistent with the conventional narrative – the downward rigidity of formal wages result in formal workers losing jobs or moving to the informal sector.

That is from Sergei Guriev, Biagio Speciale, Michele Tuccio, more data and discussion at the link.  I would note, however, that the formal and informal sector differ in ways other than just their degree of regulation.  When labor contracts are truly short-term, and there is less morale-building in the enterprise, wages may be less sticky for non-legal reasons.  And those are the firms most likely to end up in the informal sector.  Still, there is an interesting and striking contrast.

Piketty, Housing, and Capital Share

by on October 13, 2016 at 12:30 pm in Economics | Permalink

Gianni La Cava has a very interesting article (based on a longer paper) on what accounts for the rising share of capital in the income accounts:

A key observation in Thomas Piketty’s Capital in the Twenty-First Century (Piketty 2014) is that the share of aggregate income accruing to capital in the US has been rising steadily in recent decades. The growing disparity between the income going to wage earners and capital owners has led to calls for government intervention. But for such interventions to be effective, it is important to ask who the capital owners are.

Recent research has shown that the long-run rise in the net capital income share is mainly due to the housing sector (e.g. Rognlie 2015, Torrini 2016 – see Figure 1). This phenomenon is not specific to the US but has been evident in almost every advanced economy. This suggests that it is not entrepreneurs and venture capitalists that are taking an increasing share of the economy, but land owners.

…The decomposition of the national accounts by type of housing indicates that the secular rise is mainly due to a rising share of imputed rent going to owner-occupiers. The owner-occupier share of aggregate income has risen from just under 2% in 1950 to close to 5% in 2014 (top panel of Figure 2). The share of income going to landlords (i.e. market rent) has also doubled in the post-war era. But, in aggregate, the effect of imputed rent is larger simply because there are nearly twice as many home owners as renters in the US economy. A similar phenomenon is observed in the personal consumption expenditure data (bottom panel of Figure 2). In other words, today’s landed gentry are predominantly home owners, not private landlords.

…The geographic decomposition reveals that the long-run rise in the housing capital income share is fully concentrated in states that face housing supply constraints. To see this, I divide the states into ‘elastic’ and ‘inelastic’ groups based on whether the state is above or below the median housing supply elasticity index (as measured by Saiz 2010). This index captures both geographical and regulatory constraints on home building across different US regions. For 50 years, the share of total housing capital income going to the supply-elastic states has been unchanged at about 3% of GDP (Figure 3). In contrast, the share going to the supply-inelastic states has risen from around 5% in the 1960s to 7% of GDP more recently. Notably, these divergent trends in housing capital income are not due to a few ‘outlier’ states where housing supply is particularly constrained, such as New York or California – instead, there is a clear negative correlation between the long-run growth in housing capital income and the extent to which housing supply is constrained across all states (Figure 4).

In 1980, 66% of high-skilled men worked in cognitive occupations. Over the next 20 years, this proportion fell by 3 percentage points (pp) to 63%. Interestingly, this fall in the probability of working in a COG job was accompanied by a 3 pp rise in the fraction of college educated men not working (unemployed or out of the labor force).

That is from recent research by Cortes, Jaimovich, and Siu (pdf).  You will note that the chance of a woman working in those jobs rose over the same period, even though the supply of educated women relative to the supply of educated men went up a great deal over that same time period.  They find that the increasing importance of “female-oriented” social skills is a major reason for why women have so increased their presence in cognitive occupations.

Similar claims are very much a theme in my last book, Average is Over, so I am happy to see them verified in a more definitive manner.

The plummeting pound is threatening UK households’ supplies of Ben & Jerry’s ice cream and Marmite spread, as Tesco, the country’s biggest supermarket, pulled dozens of products from sale online in a row over who should bear the cost of the weakening currency.

Unilever has demanded steep price increases to offset the higher cost of imported commodities, which are priced in euros and dollars, according to executives at multiple supermarket groups.

But Tesco signalled it would fight the rises, removing Unilever products from its website and warning that some of the items could disappear from shelves if the dispute dragged on. Other supermarkets have warned that they could follow suit.

Here is the full FT story.

Maybe so, but I have a sneaking suspicion they are not about to get much of it, not anytime soon.  Corina Ruhe reports, and I say put on your Bayesian thinking cap for this bit:

Bundesbank board member Andreas Dombret…said in an interview with Boersen-Zeitung that the revised rules, due by year-end, mustn’t disproportionately affect European banks. “Not significant means an increase of zero percent or near to zero percent; that has to be the starting point for all negotiations,” he said.

I like to negotiate that way too, when I can.  What might the French be saying?:

“We are in favor of Basel III, but we think it is unhelpful, even dangerous, to want to add layer upon layer of obligations on banks, in particular on European banks,” French Finance Minister Michel Sapin said on Monday.

Are you starting to see a pattern?  Neither the governments nor the banks would find it very simple to cough up the extra resources to boost capital.  And cross-border or other mergers would lead to higher capital requirements yet, given the way the regulations are written to penalize increases in bank size.

Did you know that the ECB gave Deutsche Bank special treatment in its recent stress tests?  Still, I think it is more likely that Deutsche Bank is a slow wasteful drain rather than the next explosive Lehman Brothers, if only because the level of financial risk paranoia is so high.

The more fundamental point is that there is significant excess capacity in European banking.  That makes it hard for DB to get back on its feet, and it may send other European banks to a similar fate, creating a chronic problem though probably not a dramatic crisis.  The bank-dependent EU economies don’t have a simple way to make their banking sectors shrink a lot more.  Whether or not this is necessary right now or rather later, either way it will feel a lot like that ill-defined concept “austerity.”

Remember this?:

“Global banks are international in life but national in death,” former Bank of England governor Mervyn King once noted.

More fundamentally, there is excess capacity when it comes to EU governments as well, a less frequently recognized point.  There is more and more governance, some of it good in fact, but it never goes away.  There are whole new levels of governance, connected to the EU.  Somewhere in the system, governance too needs to shrink.  Losing a few countries through consolidation is not possible, but in terms of the pure logic (divorced from actual fact and possibilities), there is something to be said for the idea.  And yet we are relying on governance to get the banks to shrink.  And relying on the banks to boost growth so that governance can shrink.  Relying on relying.

Get the picture?

One of Nobel prize-winner Oliver Hart’s most influential papers (co-authored with Andrei Shleifer and Robert Vishny) is on incentive design and private prisons (see Tyler’s post covering Hart’s work). Yesterday was not the day for a critique but Tyler and I do critique this paper in our principles textbook, Modern Principles. I believe that our textbook is the only principles textbook to have a chapter on contract design and we make this modern material accessible to undergraduates! Here is our explanation and critique:

Should the management of prisons be contracted out to the private sector? The
owners of a private firm have a strong incentive to cut costs and improve productivity because they get to keep the resulting profits. If a public prison cuts
costs, there is more money in the public treasury but no one gets to buy a yacht so the incentive to cut costs is much weaker.

private_prisonIn 1985, Kentucky became the first state to contract out a prison to a for profit firm. Private prisons today hold about 120,000 prisoners in the United
States, about 5 percent of all prisoners. Should efficient private prisons replace
inefficient public prisons? Three economists—Oliver Hart, Andrei Shleifer, and
Robert Vishny (HSV)—say no. HSV don’t question that the profit motive gives
private prisons stronger incentives than public prisons to cut costs—HSV say
that’s the problem! Suppose that we care about costs but we also care about
prisoner rehabilitation, civil rights, and low levels of inmate and guard violence.
What we pay for is cheap prisons, but what we want is cheap but high quality
prisons. If we can’t measure and pay for quality, then strong incentives could
encourage cost cutting at the expense of quality.

The principle is a general one, a strong incentive scheme that incentivizes
the wrong thing can be worse than a weak incentive scheme. One car dealer in
California advertises that its sales staff is not paid on commission.
 Why would
a store advertise that its sales staff do not have strong incentives to help you?
The answer is clear to anyone who has tried to buy a car. High-pressure dealers
who pounce on you the moment you enter the showroom and bombard you
with high-pressure sales tactics (“I can get you 15 percent off the sticker, but
you have to act NOW!”) may sell cars to first-time buyers, but the strategy is
too unpleasant to win many repeat customers. Car dealers who rely on repeat
business usually prefer a low-pressure, informative sales staff….
In theory, a car dealer could have strong incentives and repeat business by
paying its sales staff based on their “nice” sales tactics, but in practice it’s too
expensive to monitor how salespeople interact with clients. Cheating by the
sales staff would be difficult to detect and thus would be common. 

What about prisons? Are HSV correct that weak-incentive public prisons
are better than strong incentive private prisons? Not necessarily. HSV assume
that cutting quality is the way to cut cost. But sometimes higher quality is also
a path to lower costs. Low levels of inmate and guard violence, for example, are
likely to reduce costs. And respect for prisoner’s civil rights? That can save on
legal bills. When quality and cost cutting go together, a private firm has a strong
incentive to increase quality.

HSV may also underestimate how well quality can be measured. Measuring
output pays off more when incentives are high. Unsurprisingly, therefore,
private prison companies and government purchasers have made extensive
efforts to measure the quality of private prisons.

Finally, don’t forget that weak incentives reduce the incentive to cut costs
but they don’t increase the incentive to produce high quality! Public prisons
might use their slack budget constraints to offer high-quality rehabilitation
programs, or they might instead offer prison guards above-market wages.
Which do you think is more likely?

Nevertheless, whether HSV are right or wrong about private prisons, their
argument is clever. The usual argument against government bureaucracy is that
without the profit incentive, public bureaucracies won’t have an incentive to
cut costs. HSV suggest this is exactly why public bureaucracies may sometimes
be better than private firms.

Addendum: We don’t go through the empirical literature in the text but overall it’s not supportive of HSV. As HSV predict, private prisons appear to be cheaper than public prisons but they are not significantly cheaper and the quality of private prisons is comparable to that of public prisons and maybe a little bit higher (faint praise). Basically the government gets what it pays for.

Sebastian Galiana and Gustavo Torrens have a new NBER paper on this underappreciated question:

Why did the most prosperous colonies in the British Empire mount a rebellion? Even more puzzling, why didn’t the British agree to have American representation in Parliament and quickly settle the dispute peacefully? At first glance, it would appear that a deal could have been reached to share the costs of the global public goods provided by the Empire in exchange for political power and representation for the colonies. (At least, this was the view of men of the time such as Lord Chapman, Thomas Pownall and Adam Smith.) We argue, however, that the incumbent government in Great Britain, controlled by the landed gentry, feared that allowing Americans to be represented in Parliament would undermine the position of the dominant coalition, strengthen the incipient democratic movement, and intensify social pressures for the reform of a political system based on land ownership. Since American elites could not credibly commit to refuse to form a coalition with the British opposition, the only realistic options were to maintain the original colonial status or fight a full-scale war of independence.

You may recall that Adam Smith wanted to see a continuing empire, but with North America as essentially the more powerful partner, though he did not quite use those words.

Holmstrom’s work has provided me with a great deal of understanding of why innovation management looks the way it does. For instance, why would a risk neutral firm not work enough on high-variance moonshot-type R&D projects, a question Holmstrom asks in his 1989 JEBO Agency Costs and Innovation? Four reasons. First, in Holmstrom and Milgrom’s 1987 linear contracts paper, optimal risk sharing leads to more distortion by agents the riskier the project being incentivized, so firms may choose lower expected value projects even if they themselves are risk neutral. Second, firms build reputation in capital markets just as workers do with career concerns, and high variance output projects are more costly in terms of the future value of that reputation when the interest rate on capital is lower (e.g., when firms are large and old). Third, when R&D workers can potentially pursue many different projects, multitasking suggests that workers should be given small and very specific tasks so as to lessen the potential for bonus payments to shift worker effort across projects. Smaller firms with fewer resources may naturally have limits on the types of research a worker could pursue, which surprisingly makes it easier to provide strong incentives for research effort on the remaining possible projects. Fourth, multitasking suggests agent’s tasks should be limited, and that high variance tasks should be assigned to the same agent, which provides a role for decentralizing research into large firms providing incremental, safe research, and small firms performing high-variance research. That many aspects of firm organization depend on the swirl of conflicting incentives the firm and the market provide is a topic Holmstrom has also discussed at length, especially in his beautiful paper “The Firm as an Incentive System”; I shall reserve discussion of that paper for a subsequent post on Oliver Hart.

That is A Fine Theorem on the work of Bengt Holmstrom, do read the whole thing.

Read it here, this is one short bit:

They’ve built a technical framework for other researchers to build on, which is much harder to do than to throw off useful insights. So don’t be underwhelmed if some of their work, when conveyed in sound bites, seems like something you heard last week at the water cooler.

Overall a simpler take than what you can read on MR below.

The Performance Pay Nobel

by on October 10, 2016 at 7:15 am in Economics, Uncategorized | Permalink

The Nobel Prize in economics goes to Oliver Hart and Bengt Holmstrom for contract theory, the design of incentives. See Tyler’s posts below for overviews. In our textbook, Modern Principles, Tyler and I have a chapter called Managing Incentives which covers some of this work, especially related to Holmstrom’s work on performance pay. Let’s give a simplified precis (fyi, the textbook doesn’t have the math).

Suppose that you are a principal monitoring an agent who produces output. The output depends on the agent’s effort but also on noise. It wouldn’t be a very efficient contract to just reward the agent based on output since then you would mostly be responding to noise—punishing hard-working agents when the noise factors were bad and rewarding lazy agents when the noise factors were good. Not only is that unfair–if you setup a contract like this the agents will a) demand that you pay them a lot of money in the good state because they will be taking on a lot of risk and b) the agents won’t put in much effort anyway since their effort will tend to be overwhelmed by the noise, either good or bad. Thus, rewarding output alone gets you the worst of all worlds, you have to pay a lot and you don’t get much effort.

But perhaps in addition to output, y, you have a signal of effort, call it s. Both y and s signal effort with noise but together they provide more information. First, lesson – use s! In fact, the informativeness principle says you should use any and all information that might signal the agent’s effort in developing your contract. But how should you combine the information from y and s? Suppose you write a contract where the agent is paid a wage, w=B0+By*y+Bs*s where Bo is the base wage, By is the beta on y, how much weight to put on output and Bs is the weight on the s signal–think of By as the performance bonus and Bs as a subjective evaluation bonus. Then it turns out (under some assumptions etc. Canice Prendergast has a good review paper) you should weight By and Bs according to the following formula:


that looks imposing but it’s really not.  σ^2s (sorry for the notation) is the variance of the s signal, σ^2y is the variance of the y signal. Now for the moment assume r is zero so the formula boils down to:


Ah, now that looks sensible because it’s an optimal information theorem. It says that you should put a high weight on y when the s signal is relatively noisy (notice that By goes to 1 as σ^2s increases) and a high weight on s when the y signal is relatively noisy. Notice also that the two betas sum to 1 which means that in this world you put all the risk on the agent. Ok, now let’s return to the first version and fill in the details. What’s r? r is a measure of risk aversion for the agent. If r is zero then the agent is risk neutral and we are in the second world where you put all the risk on the agent. If the agent is risk averse, however, then r>0 and so what happens? If r>0 then you don’t want to put all the risk on the agent because then the agent will demand too much so you take on some risk yourself and tamp down By and Bs (notice that the bigger is r the smaller are both By and Bs) and instead increase the base wage which acts as a kind of insurance against risk. So the first version combines an optimal information aggregation theorem with the economics of managing the risk-performance-pay tradeoff.

(c, by the way, is a measure of how costly effort is to the agent and so it also makes sense that the higher is c the less weight you put on performance incentives and the more on the base wage.)

Let’s also discuss some further work which is closely related to Holmstrom’s approach, tournament theory (Lazear and Rosen). When should you use absolute pay and when should you use relative pay? For example, sometimes we reward salespeople based on their sales and sometimes we reward based on which agent had the most sales, i.e. a tournament. Which is better? The great thing about relative pay is that it removes one type of noise. Suppose, for example, that sales depend on effort but also on the state of the economy. If you reward based on absolute sales then you are rewarding a lot of noise. Once again, that has two bad effects it means that you have to pay your agents a lot since you are imposing risk on them and it means that they won’t work that hard since they know they will be paid a lot when the economy is good and hardly at all when the economy is bad so in neither case do the agents have strong incentives to work hard. Suppose, however, that you have a relative pay scheme, a tournament. Now you have removed the noise coming from the state of the economy–since all the salespeople face the same economy and since there is always a first, second and third place the agent’s now have an incentive to work hard in good or bad times. Not only do they have an incentive to work hard you don’t have to pay them much of a risk premium since more of their pay is now based on their own effort rather than on noise.

But relative pay isn’t always better. If the sales agents come in different ability levels, for example, then relative pay means that neither the high ability nor the low ability agents will work hard. The high ability agents know that they don’t need to exert high effort to win and the low ability agents know that they won’t win even if they do exert high effort. Thus, if there is a lot of risk coming from agent ability then you don’t want to use tournaments. Or to put it differently, tournaments work best when agent ability is similar which is why in sports tournaments we often have divisions (over 50, under 30) or rounds.

FYI, in our textbook Tyler and I use this model to discuss when students should prefer an absolute grading scale and when they should prefer grading on a curve. Work it out!

Holmstrom’s work has lot of implications for structuring executive pay. In particular, executive pay often violates the informativeness principle. In rewarding the CEO of Ford for example, an obvious piece of information that should used in addition to the price of Ford stock is the price of GM, Toyota and Chrysler stock. If the stock of most of the automaker’s is up then you should reward the CEO of Ford less because most of the gain in Ford is probably due to the economy wide factor rather than to the efforts Ford’s CEO. For the same reasons, if GM, Toyota, and Chrysler are down but Ford is down less then you might give the Ford CEO a large bonus even though Ford’s stock price is down. Oddly, however, performance pay for executives rarely works like a tournament. As a result, CEOs are often paid based on noise.

The basic framework has since been applied in many different circumstances because principal-agent can be interpreted in many different ways employer-worker, teacher-student, regulator-banker and so forth. Thus the basic insights have been reflected in a wealth of applications each of which adds to the body of theory.

Again, I’ll be refreshing this post throughout the morning, keep on hitting refresh.  Here is Bengt Holmström’s home page, which includes a CV, short biography, and links to research papers.  Here is his Wikipedia page.  He has taught for a long time at MIT, was born in Finland, and is one of the most famous and influential economists in the field of contracts and industrial organization.  Here is the Swedish summary.  Here is a video explanation.  This is a nice short bio of how he was influenced by his private sector experience, recommended, not just the usual take on him.

One key question he has considered is when incentives should be high-powered or when they should be more blunt.  It is now well known that you get what you pay for; see Alex’s excellent summary on this and related points.

His most famous paper is his 1979 “Moral Hazard and Observability.”  What are the optimal sharing rules when the principal can observe outcomes but not efforts or inputs?  And how might those sharing rules lead to a less than optimal result?  This is probably the most elegant and most influential statement of how direct incentives and insurance value in a contract can conflict and hinder efficiency.  A simple example — what about deductibles in a health insurance contract?  Yes, they do encourage the customer to internalize the value of staying in better health.  But they also limit the insurance value of a contract.  That a first best outcome will not be created in this situation was part of what Holmstrom showed, and he showed it in a relatively tractable way.

If you are thinking about CEO compensation, you might turn to the work of Holmström,  the Swedes have a good summary of this paper and point:

…an optimal contract should link payment to all outcomes that can potentially provide information about actions that have been taken. This informativeness principle does not merely say that payments should depend on outcomes that can be affected by agents. For example, suppose the agent is a manager whose actions influence her own firm’s share price, but not share prices of other firms. Does that mean that the manager’s pay should depend only on her firm’s share price? The answer is no. Since share prices reflect other factors in the economy – outside the manager’s control – simply linking compensation to the firm’s share price will reward the manager for good luck and punish her for bad luck. It is better to link the manager’s pay to her firm’s share price relative to those of other, similar firms (such as those in the same industry).

That is again a result about how incentives and insurance interact.  When do you pay based on perceived effort, and when on the basis of observed outcomes, such as profits or share price?  Holmström has been the number one theorist in helping to address issues of this kind.

“Moral Hazard in Teams,”1982, is a very famous and influential paper, here is the working paper version.  Holmström showed that the optimal incentive scheme has to consider time consistency.  Sometimes good incentive schemes impose penalties on the workers/agents to get them to work harder.  But let’s say you had a worker-owned and worker-run firm.  If the workers fail, will the workers/owner impose punishments on themselves?  Maybe not.  Thus in a fairly general class of situations you need an outside residual claimant to impose and receive the penalty.  This is Holmström trying to justify one feature of the capitalist system against socialists and Marxists.

A Fine Theorem has an excellent post on his work.

Managerial Incentive Problems: A Dynamic Perspective” is another goodie, this one from 1999.  The key point is that repeated interactions, for instance with a manager, can make incentive problems worse rather than better.  The more the shareholders monitor a manager, for instance, and the more that is over a longer period of time, perhaps the manager has a greater incentive to manipulate signals of value.  When are career incentives beneficial or harmful?  This paper is the starting point in thinking through this problem.  Here is one of the possible traps: if a worker fully reveals his or her quality to the boss, the boss will use that information to capture more surplus from the worker.  So many workers don’t let on just how talented they are, so they can slack more, rather than being caught up in the dragnet of a ‘super-efficient” incentives scheme.  I have long found this to be a very important paper, it is probably my favorite by Holmström.

This 1994 investigation, based on personnel data from within firms, is actually way ahead of its time in terms of empirical methods.  It is certainly known but he never received full credit for it.

Holmström and Hart together have a very nice piece surveying the theory of contracts and theories of the firm.  With John Roberts, he has a very nice (and highly readable!) survey of economic work on theories of the boundary of the firm, recommended on the field more generally.  Not his most famous piece, but if you are looking in the applied direction, here is his survey piece with Steven Kaplan on mergers.

With Jean Tirole has has a 1997 paper “Financial Intermediation, Loanable Funds, and the Real Sector.”  This was an important precursor of the later point about how collateral constraints really can matter.  Firms and banks should be well-capitalized!  This piece was significantly influenced by the Nordic financial crises of the 1990s and it was prescient regarding later events in the United States and elsewhere.

His liquidity-based asset pricing model, with Jean Tirole, did not in its published form “take off” in the world of finance, but it is an excellent and important piece, worth revisiting as part of the puzzle of why the world has so many super-low interest rates today.

Holmström has since written much more about banking and agency problems.  His very latest piece is on banks as secret keepers, and it tries to model and explain the fundamental nature of banking and its fixed value liabilities.  Here is his piece on why financial panics are so likely to involve debt.  With Jean Tirole, he wrote a well-known paper on why government supply of liquidity services sometimes may be justified.

Here is his 2003 survey paper, with Steven Kaplan, on what is right and wrong in U.S. corporate governance.  It is a more applied side than what you often see from him.  The piece claims that, even in light of the scandals of that time, American corporate governance is not broken and will probably become better yet, though it could stand some improvement, including on the regulatory side.  Overall I view his co-authorships with Kaplan as suggesting that his overall stance toward corporations is more influenced by Chicago-style thinking than is oftetn the case at MIT.  Read his defense of asset securitization for instance.

Congratulations to Bengt Holmström!