Distinguishing Incentive from Selection Effects in Auction-Determined Contracts

This paper develops a novel approach to estimate how contract and principal-agent characteristics influence an ex-post performance outcome when the matching between agents and principals derives from an auction process. We propose a control-function approach to account for the endogeneity of contracts and matching. This consists of, first, estimating the primitives of an interdependent values auction model - which is shown to be non-parametrically identified from the bidding data - second, constructing control functions based on the distribution of the unobserved private signals conditional on the auction outcome. A Monte Carlo study shows that our augmented outcome equation corrects well of the endogeneity biases, even in small samples. We apply our methodology to a labor market application: we estimate the effect of sports players’ auction-determined wages on their individual performance.