Paul Milgrom

BID, ASK AND' TRANSACTION PRICES IN A SPECIALIST MARKET WITH HETEROGENEOUSLY INFORMED TRADERS*

The presence of traders with superior information leads to a positive bid-ask spread even when the specialist is risk-neutral and makes zero expected profits. The resulting transaction prices convey information, and the expectation of the average spread squared times volume is bounded by a number that is independent of insider activity. The serial correlation of transaction price differences is a function of the proportion of the spread due to adverse selection. A bid-ask spread implies a divergence between observed returns and realizable returns. Observed returns are approximately realizable returns plus what the uninformed anticipate losing to the insiders.

A theory of auctions and competitive bidding

Abstract : In Section 2, we review some important results of the received auction theory, introduce a new general auction model, and summarize the results of our analysis. Section 3 contains a formal statement of our model, and develops the properties of affiliated random variables. The various theorems are presented in Sections 4-8. In Section 9, we offer our views on the current state of auction theory. Following Section 9 is a technical appendix dealing with affiliated random variables.

AGGREGATION AND LINEARITY IN THE PROVISION OF INTERTEMPORAL INCENTIVES

The authors develop two themes in the theory of incentive schemes. First, one need not always use all of the information available in an optimal incentive contract. Accounting information, which aggregates performance over time, is sufficient for optimal compensation schemes in certain classes of environments. Second, optimal rules in a rich environment must work well in a range of circumstances and cannot, therefore, be complicated functions of the observed outcome. The authors illustrate these ideas in a particular model where the agent has a rich space of controls, showing that the unique optimal compensation scheme is a linear function of profits. Copyright 1987 by The Econometric Society.

Complementarities and fit strategy, structure, and organizational change in manufacturing

Abstract The theories of supermodular optimization and games provide a framework for the analysis of systems marked by complementarity. We summarize the principal results of these theories and indicate their usefulness by applying them to study the shift to ‘modern manufacturing’. We also use them to analyze the characteristic features of the Lincoln Electric Companys strategy and structure.

Predation, reputation, and entry deterrence

Abstract Economists often argue that predatory practices are irrational, since there exist cheaper or more certain means to gain or maintain a monopoly. Our gametheoretic, equilibrium analysis suggests that if a firm is threatened by several potential entrants, then predation may be rational against early entrants, even if it is costly when viewed in isolation, because it yields a reputation which deters other entrants. Asymmetric information plays a crucial role in our analysis, since it provides the rationale for entrants to base their expectations of the firms future behavior on its past actions. The analysis also suggests methods to treat general reputational phenomena.

Information, trade and common knowledge

Abstract In any voluntary trading process, if agents have rational expectations, then it is common knowledge among them that the equilibrium trade is feasible and individually rational. This condition is used to show that when risk-averse traders begin at a Pareto optimal allocation (relative to their prior beliefs) and then receive private information (which disturbs the marginal conditions), they can still never agree to any non-null trade. On markets, information is revealed by price changes. An equilibrium with fully revealing price changes always exists, and even at other equilibria the information revealed by price changes “swamps” each traders private information.

Monotone Comparative Statics

The authors derive a necessary and sufficient condition for the solution set of an optimization problem to be monotonic in the parameters of the problem. In addition, they develop practical methods for checking the condition and demonstrate its applications to the classical theories of the competitive firm, the monopolist, the Bertrand oligopolist, consumer and growth theory, game theory, and general equilibrium analysis. Copyright 1994 by The Econometric Society.

ENVELOPE THEOREMS FOR ARBITRARY CHOICE SETS

The standard envelope theorems apply to choice sets with convex and topological structure, providing sufficient conditions for the value function to be differentiable in a parameter and characterizing its derivative. This paper studies optimization with arbitrary choice sets and shows that the traditional envelope formula holds at any differentiability point of the value function. We also provide conditions for the value function to be, variously, absolutely continuous, left- and right-differentiable, or fully differentiable. These results are applied to mechanism design, convex programming, continuous optimization problems, saddle-point problems, problems with parameterized constraints, and optimal stopping problems.

An Economic Approach to Influence Activities in Organizations

Members of organizations spend considerable time, effort, and ingenuity attempting to influence decision makers. Such influence activities may bring benefits to the organization, but they also involve real costs. This essay offers an economic rationale for such influence activity as representing rational, self-interested behavior in the presence of informational asymmetries and an analysis of how the design of the organizations structure and polices should respond to the incentives for attempting influence. It is posited that information valuable for the organizations decision making is directly available only to members of the organization who have some personal stake in the decisions. These individuals may then have an incentive to try to manipulate the information they develop and provide in order to influence the resulting decision to their benefits. This can be costly both in degrading the quality of decision making and in diverting the attention and effort of the organizations members from more productive activities. The organization has three different methods it can employ to discourage excessive influence activities and to encourage more directly productive uses of time and effort. It can limit access to decision makers and participation in decision making; it can alter its decision-making criteria to favor those performing well in productive activities; and it can provide direct financial incentives to encourage the desired allocation of effort. It is shown that an efficiently deisgned organization will use such financial incentives only as a last resort. Instead, it will always first alter its decision-participation polices and decision-making criteria.

Putting auction theory to work : the simultaneous ascending auction

I review the uses of economic theory in the initial design and later improvement of the “simultaneous ascending auction,” which was developed initially for the sale of radio spectrum licenses in the United States. I analyze some capabilities and limitations of the auction, the roles of various detailed rules, the possibilities for introducing combinatorial bidding, and some considerations in adapting the auction for sales in which revenue, rather than efficiency, is the primary goal.