Publications

Working Paper
Hart, Oliver, and Luigi Zingales. Working Paper.

Banks Are Where The Liquidity Is

. bank_liquidity-may_25.pdf
Borek, Christopher T, and Angelo Frattarelli. Working Paper.

Tax Shelters or Efficient Tax Planning? A Theory of The Firm Perspective On the Economic Substance Doctrine, forthcoming Journal of Law and Economics

.Abstract
Courts have articulated a number of legal tests to distinguish corporate transactions that have a legitimate business or economic purpose from those carried out largely, if not solely, for favorable tax treatment. We outline an approach to analyzing the economic substance of corporate transactions based on the property rights theory of the firm, and describe its application in two recent tax cases.
borek_frattarelli_hart_-_may_21_2014.pdf
Hart, Oliver, and Luigi Zingales. Working Paper. Liquidity and Inefficient Investment.Abstract
We study consumer liquidity in a general equilibrium model where the friction is the non-pledgeability of future income. Liquidity helps to overcome the absence of a double coincidence of wants. Consumers over-hoard liquidity and the resulting competitive equilibrium is constrained inefficient. Fiscal policy following a large negative shock can increase ex ante welfare. If the government cannot commit, the ex post optimal fiscal policy will be too small from an ex ante perspective.
hart_zingales_nov.pdf
Hart, Oliver, and Maija Halonen-Akatwijuka. Working Paper. More is Less: Why Parties May Deliberately Write Incomplete Contracts.Abstract
Why are contracts incomplete? Transaction costs and bounded rationality cannot be a total explanation since states of the world are often describable, foreseeable, and yet are not mentioned in a contract. Asymmetric information theories also have limitations. We offer an explanation based on “contracts as reference points”. Including a contingency of the form, “The buyer will require a good in event E”, has a benefit and a cost. The benefit is that if E occurs there is less to argue about; the cost is that the additional reference point provided by the outcome in E can hinder (re)negotiation in states outside E. We show that if parties agree about a reasonable division of surplus, an incomplete contract can be strictly superior to a contingent contract.
more_is_less_april_19_2013-2_copy.pdf
2014
Hart, Oliver, Ernst Fehr, and Christian Zehnder. 2014. How Do Informal Agreements and Revision Shape Contractual Reference Points?, Journal of the European Economic Association: forthcoming.Abstract
The notion of contracts as reference points provides the basis for a deeper understanding of important phenomena such as the employment contract, vertical integration, firm scope, authority and delegation. Previous experiments lend support to this notion but they ignore realistic aspects of trading relationships such as informal agreements and ex post renegotiation or revision. Here we show that the central behavioral mechanism underlying contractual reference points is robust to such considerations. Our data reveal that informal agreements can mitigate the trade-off between rigidity and flexibility but they do not fully resolve the problem of misaligned reference points. Our experiments also show that contract revision is a more nuanced process than the previous literature has recognized. We find, for example, that it is sometimes better for parties to write a simple (rigid) contract and then revise it ex post if needed, rather than to anticipate and include future contingencies in a (flexible) contract from the outset.
fhz_iare_2ndrevision_jan22.pdf
2013
Hart, Oliver. 2013. Noncontractible Investments and Reference Points, Games 4, no. 3: 437-456. Games - Link to paper.Abstract
We analyze noncontractible investments in a model with shading. A seller can make an investment that affects a buyer’s value. The parties have outside options that depend on asset ownership. When shading is not possible and there is no contract renegotiation, an optimum can be achieved by giving the seller the right to make a take‐it‐or‐leave‐it offer. However, with shading, such a contract creates deadweight losses. We show that an optimal contract will limit the seller’s offers, and possibly create ex post inefficiency. Asset ownership can improve matters even if revelation mechanisms are allowed.
Borek, Christopher T, Angleo Frattarelli, and Olvier Hart. 2013. Tax shelters and the theory of the firm, VOX. Tax shelters and the theory of the firm
2011
Hart, Oliver, and Luigi Zingales. 2011. A New Capital Regulation for Large Financial Institutions, American Law and Economics Review 13, no. 2: 453-490.Abstract
We design a new capital requirement for large financial institutions (LFI) that are “too big to fail.” Our mechanism mimics the operation of margin accounts. To ensure LFIs do not default on systemically-relevant obligations, we require that they maintain a cushion of equity and junior long-term debt sufficiently great that the credit default swap price on the long-term debt stays below a threshold level. If the CDS price moves above the threshold, either LFIs issue equity to bring it down or the regulator intervenes. This mechanism ensures that LFIs are always solvent, while preserving some of the benefits of debt.
ALER-2011
Hart, Oliver. 2011. Thinking about the Firm: A Review of Daniel Spulber's 'The Theory of the Firm', Journal of Economic Literature 49, no. 1: 101-113.Abstract
In this review, I describe how economists have moved beyond the firm as a black box to incorporate incentives, internal organization, and firm boundaries. I then turn to the way that the theory of the firm is treated in Daniel Spulber’s book The Theory of the Firm:  Microeconomics with Endogenous Entrepreneurs, Firms, Markets, and Organizations. Spulber’s goal is to explain why firms exist, how they are established, and what they contribute to the economy. To accomplish this, Spulber defines a firm to be a transaction institution whose objectives differ from those of its owners. For Spulber, this separation is the key difference between the firm and direct exchange between consumers. I raise questions about whether this is a useful basis for a theory of the firm. ( JEL D21)
JEL-2011
Hart, Oliver, Ernst Fehr, and Christian Zehnder. 2011. Contracts as Reference Points-Experimental Evidence, American Economic Review 101, no. 2: 493-525.Abstract
Hart and John Moore (2008) introduce new behavioral assumptions that can explain long-term contracts and the employment relation. We examine experimentally their idea that contracts serve as ref- erence points. The evidence confirms the prediction that there is a trade-off between rigidity and flexibility. Flexible contracts—which would dominate rigid contracts under standard assumptions—cause significant shading in ex post performance, while under rigid con- tracts much less shading occurs. The experiment appears to reveal a new behavioral force: ex ante competition legitimizes the terms of a contract, and aggrievement and shading occur mainly about out- comes within the contract.
aer-2011
2010
Hart, Oliver, and Luigi Zingales. 2010. How to Make a Distressed Bank Raise Equity, Financial Times. FinancialTimes-2010
Hart, Oliver, and Luigi Zingales. 2010. “Curbing Risk on Wall Street”, National Affairs. Publisher's Version
Hart, Oliver, and Bengt Holmstrom. 2010. A Theory of Firm Scope, Quarterly Journal of Economics CXXV, no. 2: 483-513.Abstract
The formal literature on firm boundaries has assumed that ex post conflicts are resolved through bargaining. In reality, parties often simply exercise their decision rights. We develop a model, based on shading, in which the use of authority has a central role. We consider two firms deciding whether to adopt a common standard. Nonintegrated firms may fail to coordinate if one firm loses. An integrated firm can internalize the externality, but puts insufficient weight on employee benefits. We use our approach to understand why Cisco acquired StrataCom, a provider of new transmission technology. We also analyze delegation.
QJE-2010
2009
Hart, Oliver, and Luigi Zingales. 2009. How the Tricks that Crashed Wall Street Can Save the World, Foreign Policy. Publisher's Version
Hart, Oliver, and Luigi Zingales. 2009. To Regulate Finance, Try the Market, Foreign Policy. ForeignPolicy-2009
Hart, Oliver. 2009. Hold-up, Asset Ownership, and Reference Points, Quarterly Journal of Economics 124, no. 1: 267-300.Abstract
We study two parties who desire a smooth trading relationship under condi- tions of value and cost uncertainty. A contract fixing price works well in normal times because there is nothing to argue about. However, when value or cost is unusually high or low, one party will deviate from the contract and hold up the other party, causing deadweight losses as parties withhold cooperation. We show that allocating asset ownership and indexing contracts can reduce the incentives to engage in hold-up. In contrast to much of the literature, the driving force in our model is payoff uncertainty, rather than noncontractible investments.
QJE-2009
Hart, Oliver. 2009. Regulation and Sarbanes-Oxley, Journal of Accounting Research 47, no. 2: 437-445. JofAR-2009
Hart, Oliver, Ernst Fehr, and Christian Zehnder. 2009. Contracts, Reference Points, and Competition - Behavioral Consequences of the Fundamental Transformation, Journal of the European Economic Association 7, no. 2-3: 561-572.Abstract
In this paper we study the role of incomplete ex ante contracts for ex post trade. Previous experimental evidence indicates that a contract provides a reference point for entitlements when the terms are negotiated in a competitive market. We show that this finding no longer holds when the terms are determined in a non-competitive way. Our results imply that the presence of a “fundamental transformation” (i.e., the transition from a competitive market to a bilateral relationship) is important for a contract to become a reference point. To the best of our knowledge this behavioral aspect of the fundamental transformation has not been shown before. (JEL: C91, D03, D23)
JEEA-2009
2008
Hart, Oliver. 2008.

Reference Points and the Theory of the Firm

, Economica 75, no. 299: 404-411. referencepointsandthetheoryofthefirm_2.pdf
Hart, Oliver, and John Moore. 2008. Contracts as Reference Points, Quarterly Journal of Economics CXXIII, no. 1: 1-48.Abstract
We argue that a contract provides a reference point for a trading relationship: more precisely, for parties’ feelings of entitlement. A party’s ex post performance depends on whether he gets what he is entitled to relative to outcomes permitted by the contract. A party who is shortchanged shades on performance. A flexible contract allows parties to adjust their outcomes to uncertainty but causes ineffi- cient shading. Our analysis provides a basis for long-term contracts in the absence of noncontractible investments and elucidates why “employment” contracts, which fix wages in advance and allow the employer to choose the task, can be optimal.
QJE-2008