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Moral Hazard Contracting and Private Credit Markets

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  • In-Uck Park

Abstract

This paper studies the impact of credit markets on optimal contracting, when the agent's "interim preference" over upcoming contracts is private information because personal financial decisions affect it via the wealth effect. The main result is a severe loss of incentive provision: equilibrium contracts invariably cause the agent to shirk (i.e., exert minimal effort) if the agent's private financial decision precedes moral hazard contracting. The basic intuition is that committing on another private variable, other than the effort level, exposes the parties to further exploitation of efficient risk-sharing by relaxing the incentive constraint that was binding ex ante, unless the risk-sharing was fully efficient to begin with. Copyright The Econometric Society 2004.

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File URL: http://hdl.handle.net/10.1111/j.1468-0262.2004.00510.x
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Bibliographic Info

Article provided by Econometric Society in its journal Econometrica.

Volume (Year): 72 (2004)
Issue (Month): 3 (05)
Pages: 701-746

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Handle: RePEc:ecm:emetrp:v:72:y:2004:i:3:p:701-746

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Cited by:
  1. Alberto Bisin & Piero Gottardi & Adriano A. Rampini, 2004. "Managerial Hedging and Portfolio Monitoring," CESifo Working Paper Series 1322, CESifo Group Munich.
  2. Joon Song, 2008. "Perks: Contractual Arrangements to Restrain Moral Hazard," Economics Discussion Papers 650, University of Essex, Department of Economics.
  3. Zhao, Rui R., 2006. "Renegotiation-proof contract in repeated agency," Journal of Economic Theory, Elsevier, vol. 131(1), pages 263-281, November.
  4. Ábrahám, Árpád & Koehne, Sebastian & Pavoni, Nicola, 2011. "On the first-order approach in principal-agent models with hidden borrowing and lending," Journal of Economic Theory, Elsevier, vol. 146(4), pages 1331-1361, July.
  5. Rui Zhao, 2001. "On Renegotiation-Proof Contracts in Repeated Agency," Discussion Papers 01-06, University at Albany, SUNY, Department of Economics.
  6. Arpad Abraham & Nicola Pavoni, 2008. "Efficient Allocations with Moral Hazard and Hidden Borrowing and Lending: A Recursive Formulation," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 11(4), pages 781-803, October.

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