Contracts are an economic tool used to arrange transactions which are not tradable in simple spot markets. This thesis focuses on the implications of different kinds of contracts to understand behavior in complicated interactions. The first part of this thesis focuses on explicit formal contracts that provide non-linear payoffs and examines theoretically and empirically the implications for effort and risk-taking. The second part of this thesis focuses in contrast on implicit contracts. Starting from a theoretical perspective about how implicit contracts for influence buying might work in a setting that precludes explicit contracts. This helps explains empirical puzzles as well as has new predictions. I then show empirical evidence consistent with the predictions.
In the first part, I explore managerial incentive contracts. Managerial incentives induce risk-taking as well as effort. Theoretical research has long considered risk-taking a potential side effect of incentives, but empirical investigation is limited. This thesis first develops nuanced predictions about how contracts in use in many industries induce risk-taking and effort. The contracts considered match closely those used in real-world contracts. The thesis then uses exogenous variation in hedge fund manager's incentives, one of the settings where these contracts are used, to examine both performance and risk-taking. I find that, consistent with theory, being farther below a key incentive threshold increases risk-taking and decreases performance. On average, a manager's risk-taking increases 50 percent and their performance falls 2.1 percentage points when he is below the incentive threshold. I also show, consistent with the theoretical predictions, risk-taking behavior is non-monotonic; very distant managers take less risk and perform better than less distant managers. Further, I examine the role of organizational features in impacting the responsiveness to explicit incentives and the mechanisms managers use to increase risk. My results highlight the importance of risk-taking in response to incentives designed to induce effort and inform empirical research, contract design, practitioners, and policy makers. The results also show that moral hazard, not just selection, is an important determination of manager performance.
In the second part, I explore contracts for influence buying. Existing empirical evidence that finds very high actual or potential return to some campaign contributions and wonders, if contributions buy influence, why more exchange does not occur. Other empirical work has found consistent long-term relationships of contributions from interest groups to politicians. Yet, models of influence buying have treated the exchange as a simple spot transaction. This paper develops a formal model of relational influence buying between a firm and a politician where campaign contributions are exchanged for policy favors in a self-enforcing contract. This contract provides several insights. First, not all favors that have positive joint surplus to the firm and politician are contractible. Second, the model predicts that horizons of politicians will reduce the ability to raise funds. Third, the model provides empirical predictions for when firms should lobby themselves or outsource and on the structure of legislation. The first can explain why more, apparently valuable, trade does not occur. I find evidence consistent with the horizon effects from US Congress people's age and term limits in US state legislatures. The third insight speaks both to potential regulatory implications and implications for managers' influence activities. Finally, the insights from the model suggest empirical tools to detect influence buying without directly observing the favors.
