We consider a double-sided moral hazard problem where each party can renege on the signed contract since there does not exist any verifi- able performance signal. It is shown that ex-post litigation can restore incentives of the agent. Moreover, when the litigation can be settled by the parties the pure threat of using the legal system may suffice to make the principal implement first-best effort. As is shown in the paper, this finding is rather robust. In particular, it holds for sit- uations where the agent is protected by limited liability, where the parties have different technologies in the litigation contest, or where the agent is risk averse.
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Paper provided by University of Bonn, Germany in its series Bonn Econ Discussion Papers with number
bgse14_2007.
Length: 36 Date of creation: Sep 2007 Date of revision: Handle: RePEc:bon:bonedp:bgse14_2007
Contact details of provider: Postal: Bonn Graduate School of Economics, University of Bonn, Adenauerallee 24 - 26, 53113 Bonn, Germany Fax: +49 228 73 9221 Web page: http://www.bgse.uni-bonn.de/index.php?id=494
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Oliver Gürtler & Matthias Kräkel, .
"Double-Sided Moral Hazard, Efficiency Wages and Litigation,"
Discussion Papers
214, SFB/TR 15 Governance and the Efficiency of Economic Systems, Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich.
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Find related papers by JEL classification: D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law J33 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Compensation Packages; Payment Methods K41 - Law and Economics - - Legal Procedure, the Legal System, and Illegal Behavior - - - Litigation Process
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