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Commitment Contracts

Author

Listed:
  • Philip Bond
  • Gustav Sigurdsson

Abstract

We analyse a consumption-saving problem in which time-inconsistent preferences generate demand for commitment, but uncertainty about future consumption needs generates demand for flexibility. We characterize in a standard contracting framework the circumstances under which this combination is possible, in the sense that a commitment contract exists that implements the desired state-contingent consumption plan, thus offering both commitment and flexibility. The key condition that we identify is a preference reversal condition: high desired consumption today should be associated with low marginal utility at future dates. Moreover, there are conditions under which preference reversal naturally arises. The key insight of our article is that time-inconsistent preferences not only generate commitment problems, but also allow their possible solution, since the preferences of later selves can be exploited to punish overconsumption by earlier selves.

Suggested Citation

  • Philip Bond & Gustav Sigurdsson, 2018. "Commitment Contracts," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 85(1), pages 194-222.
    • Handle: RePEc:oup:restud:v:85:y:2018:i:1:p:194-222.
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    File URL: http://hdl.handle.net/10.1093/restud/rdx041
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    Citations

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    Cited by:

    1. D'Acunto, Francesco & Xie, Jin & Yao, Jiaquan, 2022. "Trust and contracts: Empirical evidence," LawFin Working Paper Series 32, Goethe University, Center for Advanced Studies on the Foundations of Law and Finance (LawFin).
    2. Fahn, Matthias & Seibel, Regina, 2022. "Present bias in the labor market – when it pays to be naive," Games and Economic Behavior, Elsevier, vol. 135(C), pages 144-167.
    3. Kang, Jingoo & Kang, Minwook, 2022. "Durable goods as commitment devices under quasi-hyperbolic discounting," Journal of Mathematical Economics, Elsevier, vol. 99(C).
    4. Cetemen, Doruk & Feng, Felix Zhiyu & Urgun, Can, 2023. "Renegotiation and dynamic inconsistency: Contracting with non-exponential discounting," Journal of Economic Theory, Elsevier, vol. 208(C).
    5. Andersen, Torben M. & Bhattacharya, Joydeep & Liu, Pan, 2023. "Commitment and partial naïveté: Early withdrawal penalties on retirement accounts," Journal of Mathematical Economics, Elsevier, vol. 106(C).
    6. Lawrence Jin & Minwook Kang, 2022. "Addiction, present‐bias, and self‐restraint," Southern Economic Journal, John Wiley & Sons, vol. 89(1), pages 138-159, July.
    7. Jin, Lawrence & Kang, Minwook, 2023. "Human-capital investments as a commitment device," Economic Modelling, Elsevier, vol. 126(C).

    More about this item

    Keywords

    Hyperbolic discounting; time inconsistency;

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making

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