Essays in Microeconomic Theory

Open Access
Basu, Somdutta
Graduate Program:
Doctor of Philosophy
Document Type:
Date of Defense:
July 17, 2014
Committee Members:
  • Kalyan Chatterjee, Dissertation Advisor
  • Kalyan Chatterjee, Committee Chair
  • Vijay Krishna, Committee Member
  • James Schuyler Jordan, Committee Member
  • Steven J Huddart, Committee Member
  • Reputation
  • Issuer-Pays
  • Competition
  • Individual Liability
  • Informal Insurance
The first chapter of my thesis “Reputation For Two Audiences: Rating Agencies, Auditors, and Issuer-Pays Markets” considers a dynamic model of reputation formation with two audiences. The motivation for studying this model comes from the issuer-pays feature of many certification intermediary markets such as auditors and credit rating agencies. In financial markets, certification intermediaries like auditors and credit rating agencies acquire information about the financial health of a firm. The information these intermediaries provide is used by investors in order to mitigate information risks. This paper investigates whether in a litigation free world reputation concerns can lead to a socially efficient outcome, that is, whether reputation concerns can provide incentives for auditors to expend effort in order to produce high quality auditing. This paper also investigates whether competition among the auditors improves reputational incentives.Reputation of an auditor is modeled as the market belief about his informativeness, which is exogenously given. There are two types of auditors, “informative” and “uninformative”. In a monopoly set up, under imperfect monitoring, the informative auditor is diligent only for a low range of reputation. Gains from reputation shrink as the market becomes almost convinced about the auditor's type which leads to a continuum of threshold equilibria. The desired "high effort" equilibrium, which is also socially efficient, occurs only under the restrictive assumption of perfect monitoring. Comparing a duopoly and a monopoly model, I show that the range of reputation for which diligence can be sustained (when cost of diligence is small) is larger under monopoly. Reputation incentives are further weakened in a duopoly set up when firms have private information about the quality of their projects. The second chapter “Competition: Boon or Bane for Reputation Building Behavior” is a joint work with Yu Awaya. This paper investigates whether competition aids or hinders reputation building behavior in experience goods markets. We examine a market where long lived firms face a short term incentive to put low effort. There are two types of firms, “good” firms to whom high effort is costless and “opportunistic” firms who have to pay a small cost for high effort. We characterize the equilibrium strategies of a monopolist and a duopolist for a two period model. Contrary to the prevalent idea that competition improves reputation-building behavior we find that competition may hinder reputation building behavior by shrinking expected future payoffs. Horner (2002) talks about a perfectly competitive market and emphasizes the importance of outside options generated through competition. Our model on the other hand compares a duopoly model with a monopoly model in an environment of price competition. This paper focuses on how competition shrinks expected future payoff and reduces reputation incentives. We also examine the case where a planner can observe the hired firm's type and can dictate the chosen firm's actions. We show under such circumstances the duopolist's choice of effort always coincides with or falls below the effort level the planner prescribes. The third chapter “Informal Insurance and Group Size Under Individual Liability Loans” is a joint work with Souvik Dutta. There has been a recent shift from joint liability to group loans with individual liability by the Grameen Bank and some other prominent micro lending institutions across the world. Under the joint liability lending mechanism a group of individuals were given a loan and individuals in a group were jointly liable for the loan given. Under the new lending regime a group of individuals are given their individual shares of a group loan. Although they have to be in a group in order to have access to the loan, individuals are not liable for the loan of other members in the group. An individual is only liable for her share of the loan. Some recent field experiments observed no change in repayment rates with this regime change. This paper investigates the role of informal insurance among group members to explain the success of group lending with individual liability. We consider a model with finite number of players (villagers) who interact repeatedly. Each villager can invest in a project that can be a success or a failure. Villagers simultaneously obtain a loan from the microcredit organization (bank) at a fixed interest rate. The bank specifies a punishment function which is increasing and convex in the amount of loan not repaid. Individuals have exogenous bilateral arrangements specifying the amount a successful individual transfers to an unsuccessful individual. The realization of output is private information and villagers pay back their loans in a public meeting. An individual’s true outcome is revealed with a positive probability in the meeting. We consider a Perfect Bayesian Equilibrium where players repay the entire amount to the bank and keep their promises if successful. We show that with informal insurance individual liability lending can lead to the same repayment rates as joint liability. However individuals’ welfare is strictly lower under individual liability lending. In addition, this paper also sheds light on the optimal group size that villagers should maintain under the new lending mechanism.