Course Description

Contract theory studies the design of contractual, legal, and organizational arrangements in the presence of asymmetric information. The conceptual tools of contract theory, focusing on moral hazard, adverse selection and screening problems, are applied to a broad set of topics, including the design of managerial incentive systems, financial contracts, financial regulation, financial reporting, as well as the allocation of control and decision rights.

The objective of the course is to provide participants with the knowledge to understand and analyse theoretical papers on a broad range of information problems in finance and accounting. Topics include, for example, managerial compensation, earnings management, myopic investment, voluntary and strategic disclosure, financial stability, and covenants.

The course consist of lectures, exercises, and paper discussions.

• I follow the book Contract Theory by Patrick Bolton and Mathias Dewatripont to develop the foundations of key concepts.

• The lectures will be accompanied by problem sets, which I will distribute in class. We will discuss the solutions to some of the exercises in class.

• Each student has to present one paper, which is assigned in the first session.

Successful completion of the class requires active class participation, preparation and discussion of exercises, a paper presentation, and participation in a final exam. Participants are required to work through the relevant chapters in Contract Theory and selected papers. It is essential that all participants try to solve the exercises prior to the discussion of the solution in class.

The course is for Ph.D. students in finance and accounting, who completed Corporate Finance in the VGSF program or have some formal background in game theory or information economics. If you are in doubt, please write me an Email indicating prior courses you took.

Topics and Papers

We cannot cover all topics in depth and even have to skip important papers. The course overview below includes selected papers that we do not cover, but which are suggested readings if you are interested to learn more about specific topics. We cover literature references marked with ** (including exercises and presentations by participants), and papers marked with * are highly recommended reading given the focus of the class.

A Note on Paper Discussions

The emphasis is on using the papers to learn how to conduct analytical research, how to evaluate theoretical contributions, and possible links between theoretical and empirical work.

In reading each paper, you should try to answer these generic questions:

(1) What is the question being asked? Why is it interesting and/or important? To whom is it interesting?

(2) How was the analysis structured? How might the analysis have been structured differently? What assumptions were made? What assumptions were made for mathematical convenience and what assumptions drive the results? Are the assumptions reasonable?

(3) What are the major / primary results? Do they make sense?

(4) How can the paper be improved, extended, or generalized, either to answer a related (but different) question, to "test" the sensitivity of the existing answer, or to broaden the applicability of the answer?

(5) To the extent possible, how does the paper relate to other papers or lines of research?