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A quantitative exploration of self-enforcing dynamic contract theory

This dissertation studies three different aspects linked to the literature on self-enforcing
dynamic contracts. Namely, this dissertation examines how a solution to this type of economic
models may be obtained numerically, how important enforcement issues might be
for a common question in economics, and how the presence of self-enforcing constraints
may be investigated empirically. It is composed of three essays. The first essay develops
a numerical method designed to approximate the solution of models with self-enforcing
constraints using a dynamic programming approach. This method may also be used to
approximate the solution of general dynamic models with occasionally binding inequality
constraints. It complements standard value function iteration algorithm with an interpolation
scheme which preserves the concavity and the monotonicity of the value function. It
has the advantage over usual value function iteration algorithms of procuring a reasonable
degree of accuracy at a relatively lower computational cost.
The second essay uses dynamic contract theory to analyze the joint behavior of investment
decisions and financial flows when contracts between lenders and borrowers are
subject to enforcement constraints. In contrast to the usual belief that financing constraints
lead firms to underinvest, this essay shows that firms are likely to overinvest.
While overinvestment is shown to be consistent with the empirical finding that investment
spending is excessively sensitive to variations in internal funds' abundance, it does not
give rise to a financial accelerator. The key feature of this model is that firms' production
and financial capacities are simultaneously determined. Firms overinvest when external
funds are relatively inexpensive if they apprehend the possibility of becoming financially
constrained in the future. By increasing their production capacity in such a way, firms
alleviate eventual shortages of funds arising from the fact that external finance has become
Finally, the third essay studies how a common implication arising from the literature
on self-enforcing contracts may be tested empirically. A key feature of a long-term
self-enforcing contract is that the quantity subject to its terms evolves over time according
to a simple updating rule; it is set to its full-enforcement level whenever doing so
does not induce one of the agents to renege. Otherwise, it is set to a self-enforcing level.
Using the example of Thomas and Worrall's (1988) labor contract model (to which productivity
growth is added), it is shown that this updating rule may be expressed as an
endogenous switching-regression model. Panel data may be used to estimate this model.
When there are measurement errors, Monte-Carlo experiments show that the switchingregression
model usually has a poor goodness of fit in small data sets. However, despite
this finding, tests of the null hypothesis that conventional contract models generate the
data under scrutiny still have a high power against the alternative hypothesis that this
data is characterized by the presence of enforcement constraints.
Date05 1900
CreatorsSigouin, Christian
Source SetsLibrary and Archives Canada ETDs Repository / Centre d'archives des thèses électroniques de Bibliothèque et Archives Canada
Detected LanguageEnglish
TypeElectronic Thesis or Dissertation
RelationUBC Retrospective Theses Digitization Project []

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