IDEAS home Printed from https://ideas.repec.org/p/sef/csefwp/258.html
   My bibliography  Save this paper

Contracts with Wishful Thinkers

Author

Abstract

Managers with anticipatory emotions have higher current utility if they are optimistic about the future. We study an employment contract between an (endogenously) optimistic manager and realistic investors. The manager faces a trade-off between ensuring that the chosen levels of effort reflect accurate news and savoring emotionally beneficial good news. We show that optimism may exacerbate incentive problems. Specifically, investors and manager agree over the optimal news recall when the manager's weight on anticipatory utility is low. For intermediate values, there is a conflict of interest and investors bear an extra-cost to have the manager recalling bad news. For high weights on anticipatory utility, investors become indifferent between inducing signal recollection or not, and a pooling equilibrium obtains, reminiscent of adverse selection models. We then extend the analysis to the case in which the parameter capturing anticipatory utility is the manager's private information. Last, we derive interesting testable predictions on the relationship between personality traits, managerial compensation and hiring policies.In a setting with a wishful thinking agent and a realistic principal, the paper studies how incentive contracts should be designed to control for both moral hazard and self-deception. The properties of the contract that reconciles the agent with reality depend on the weight the agent attaches to anticipatory utility. When this is small, principal and agent agree on full recollection. For intermediate values the principal bears an extra cost to make the agent recall bad news. For large weights the principal renounces inducing signal recollection. We extend the analysis to the case in which the parameter of anticipatory utility is private information. The distinction between the two settings assumes practical relevance if preferences can be related to personality characteristics as in this case the parameter of anticipatory utility could be learned through psychological testing.

Suggested Citation

  • Annamaria Menichini & Giovanni Immordino & Maria Grazia Romano, 2010. "Contracts with Wishful Thinkers," CSEF Working Papers 258, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy, revised 28 Oct 2012.
  • Handle: RePEc:sef:csefwp:258
    Note: A previous version has been circulated under the title “Optimal Compensation Contracts for Optimistic Managers.
    as

    Download full text from publisher

    File URL: http://www.csef.it/WP/wp258.pdf
    Download Restriction: no
    ---><---

    Other versions of this item:

    References listed on IDEAS

    as
    1. Rabin, Matthew, 1994. "Cognitive dissonance and social change," Journal of Economic Behavior & Organization, Elsevier, vol. 23(2), pages 177-194, March.
    2. Camerer, Colin F & Hogarth, Robin M, 1999. "The Effects of Financial Incentives in Experiments: A Review and Capital-Labor-Production Framework," Journal of Risk and Uncertainty, Springer, vol. 19(1-3), pages 7-42, December.
    3. Canice Prendergast, 1999. "The Provision of Incentives in Firms," Journal of Economic Literature, American Economic Association, vol. 37(1), pages 7-63, March.
    4. Andrew Caplin & John Leahy, 2001. "Psychological Expected Utility Theory and Anticipatory Feelings," The Quarterly Journal of Economics, Oxford University Press, vol. 116(1), pages 55-79.
    5. John Smith, 2009. "Imperfect Memory and the Preference for Increasing Payments," Journal of Institutional and Theoretical Economics (JITE), Mohr Siebeck, Tübingen, vol. 165(4), pages 684-700, December.
    6. Piccione, Michele & Rubinstein, Ariel, 1997. "On the Interpretation of Decision Problems with Imperfect Recall," Games and Economic Behavior, Elsevier, vol. 20(1), pages 3-24, July.
    7. Giovanni Immordino & Anna Maria C. Menichini & Maria Grazia Romano, 2015. "Contracts with Wishful Thinkers," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 24(4), pages 863-886, October.
    8. Cooper, Arnold C. & Woo, Carolyn Y. & Dunkelberg, William C., 1988. "Entrepreneurs' perceived chances for success," Journal of Business Venturing, Elsevier, vol. 3(2), pages 97-108.
    9. Junichiro Ishida, 2006. "Optimal Promotion Policies with the Looking-Glass Effect," Journal of Labor Economics, University of Chicago Press, vol. 24(4), pages 857-878, October.
    10. Bauke Visser, 2007. "Motivating Through Delegating Tasks or Giving Attention," Journal of Law, Economics, and Organization, Oxford University Press, vol. 23(3), pages 731-742, October.
    11. Loewenstein, George, 1987. "Anticipation and the Valuation of Delayed Consumption," Economic Journal, Royal Economic Society, vol. 97(387), pages 666-684, September.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Giovanni Immordino & Anna Maria C. Menichini & Maria Grazia Romano, 2015. "Contracts with Wishful Thinkers," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 24(4), pages 863-886, October.
    2. Luc Bridet & Peter Schwardmann, 2020. "Selling Dreams: Endogenous Optimism in Lending Markets," CESifo Working Paper Series 8271, CESifo.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Michael T. Rauh & Giulio Seccia, 2010. "Agency and Anxiety," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 19(1), pages 87-116, March.
      • Michael T. Rauh & Giulio Seccia, 2006. "Agency and Anxiety," Working Papers 2006-02, Indiana University, Kelley School of Business, Department of Business Economics and Public Policy.
    2. Macera, Rosario, 2014. "Dynamic beliefs," Games and Economic Behavior, Elsevier, vol. 87(C), pages 1-18.
    3. Benoît S. Y. Crutzen & Otto H. Swank & Bauke Visser, 2013. "Confidence Management: On Interpersonal Comparisons in Teams," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 22(4), pages 744-767, December.
    4. Chen, Si, 2012. "Optimistic versus Pessimistic--Optimal Judgemental Bias with Reference Point," MPRA Paper 50693, University Library of Munich, Germany.
    5. Roland Benabou & Jean Tirole, 2009. "Over My Dead Body: Bargaining and the Price of Dignity," American Economic Review, American Economic Association, vol. 99(2), pages 459-465, May.
    6. Jose Apesteguia & Ignacio Palacios-Huerta, 2010. "Psychological Pressure in Competitive Environments: Evidence from a Randomized Natural Experiment," American Economic Review, American Economic Association, vol. 100(5), pages 2548-2564, December.
    7. Francesca Lipari, 2018. "This Is How We Do It: How Social Norms and Social Identity Shape Decision Making under Uncertainty," Games, MDPI, Open Access Journal, vol. 9(4), pages 1-31, December.
    8. Tirole, Jean, 2002. "Rational irrationality: Some economics of self-management," European Economic Review, Elsevier, vol. 46(4-5), pages 633-655, May.
    9. Gottlieb, Daniel, 2014. "Imperfect memory and choice under risk," Games and Economic Behavior, Elsevier, vol. 85(C), pages 127-158.
    10. Timothy N. Cason & Daniel Woods & Mustafa Abdallah & Saurabh Bagechi & Shreyas Sundaram, 2021. "Network Defense and Behavior Biases: An Experimental Study," Purdue University Economics Working Papers 1328, Purdue University, Department of Economics.
    11. Senik, Claudia, 2008. "Is man doomed to progress?," Journal of Economic Behavior & Organization, Elsevier, vol. 68(1), pages 140-152, October.
    12. Simon Gächter & Lingbo Huang & Martin Sefton, 2016. "Combining “real effort” with induced effort costs: the ball-catching task," Experimental Economics, Springer;Economic Science Association, vol. 19(4), pages 687-712, December.
    13. Kocher, Martin G. & Krawczyk, Michal & van Winden, Frans, 2014. "‘Let me dream on!’ Anticipatory emotions and preference for timing in lotteries," Journal of Economic Behavior & Organization, Elsevier, vol. 98(C), pages 29-40.
    14. Klein Teeselink, Bouke & Potter van Loon, Rogier J.D. & van den Assem, Martijn J. & van Dolder, Dennie, 2020. "Incentives, performance and choking in darts," Journal of Economic Behavior & Organization, Elsevier, vol. 169(C), pages 38-52.
    15. Manel Baucells & Silvia Bellezza, 2017. "Temporal Profiles of Instant Utility During Anticipation, Event, and Recall," Management Science, INFORMS, vol. 63(3), pages 729-748, March.
    16. de la Rosa, Leonidas Enrique, 2011. "Overconfidence and moral hazard," Games and Economic Behavior, Elsevier, vol. 73(2), pages 429-451.
    17. Schweizer, Nikolaus & Szech, Nora, 2016. "Optimal revelation of life-changing information," Working Paper Series in Economics 90, Karlsruhe Institute of Technology (KIT), Department of Economics and Management.
    18. Olafsson, Arna & Pagel, Michaela, 2017. "The Ostrich in Us: Selective Attention to Financial Accounts, Income, Spending, and Liquidity," CEPR Discussion Papers 12259, C.E.P.R. Discussion Papers.
    19. Gürtler, Oliver, 2006. "Job Promotion Tournaments and Imperfect Recall," Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems 112, Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich.
    20. Klaus Wälde & Agnes Moors, 2016. "Current Emotion Research in Economics," Working Papers 1612, Gutenberg School of Management and Economics, Johannes Gutenberg-Universität Mainz.

    More about this item

    Keywords

    Self-deception; anticipatory utility; contracts;
    All these keywords.

    JEL classification:

    • D03 - Microeconomics - - General - - - Behavioral Microeconomics: Underlying Principles
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:sef:csefwp:258. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: . General contact details of provider: https://edirc.repec.org/data/cssalit.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Lia Ambrosio (email available below). General contact details of provider: https://edirc.repec.org/data/cssalit.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.