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Financing Multi-stage projects under moral hazard and limited commitment

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  • Josepa Miquel-Florensa

    ()
    (Department of Economics, York University)

Abstract

We present the optimal contract for financing a project that has N stages to be completed sequentially when the principal can not commit to abandone the project before it is completed and the project to be completed is valued by the agent. In a dynamic moral hazard setting, we find that the optimal contract provides decreasing transfers for successive unsuccessful attempts in a given stage, and smaller transfers when the subsequent stages are reached. We find that the optimal sequence of transfers is greater the bigger is the exogenous probability of returning to a preceding stage and the greater the principal’s cost of stage verification is. When intermediate stages are valued by the agent, we find that smaller transfers are optimal.

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File URL: http://dept.econ.yorku.ca/research/workingPapers/working_papers/2007/StagesFeb14_2007.pdf
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Bibliographic Info

Paper provided by York University, Department of Economics in its series Working Papers with number 2007_4.

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Length: 24 pages
Date of creation: May 2007
Date of revision:
Handle: RePEc:yca:wpaper:2007_4

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Keywords: Dynamic contracts; Moral Hazard; Foreign Aid; multi-stage projects;

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  1. Svensson, Jakob, 1997. "When is foreign aid policy credible : aid dependence and conditionality," Policy Research Working Paper Series 1740, The World Bank.
  2. David Dollar & Craig Burnside, 2000. "Aid, Policies, and Growth," American Economic Review, American Economic Association, vol. 90(4), pages 847-868, September.
  3. Alberto Alesina & David Dollar, 1998. "Who Gives Foreign Aid to Whom and Why?," NBER Working Papers 6612, National Bureau of Economic Research, Inc.
  4. Dreher, Axel, 2002. "The development and implementation of IMF and World Bank conditionality," HWWA Discussion Papers 165, Hamburg Institute of International Economics (HWWA).
  5. Spear, Stephen E & Srivastava, Sanjay, 1987. "On Repeated Moral Hazard with Discounting," Review of Economic Studies, Wiley Blackwell, vol. 54(4), pages 599-617, October.
  6. Michael A. Clemens & Steven Radelet & Rikhil Bhavnani, 2004. "Counting chickens when they hatch: The short-term effect of aid on growth," International Finance 0407010, EconWPA.
  7. Craig Burnside & David Dollar, 2004. "Aid, Policies, and Growth: Reply," American Economic Review, American Economic Association, vol. 94(3), pages 781-784, June.
  8. William Easterly & Ross Levine & David Roodman, 2004. "Aid, Policies, and Growth: Comment," American Economic Review, American Economic Association, vol. 94(3), pages 774-780, June.
  9. Azam, Jean-Paul & Laffont, Jean-Jacques, 2003. "Contracting for aid," Journal of Development Economics, Elsevier, vol. 70(1), pages 25-58, February.
  10. Benveniste, L M & Scheinkman, J A, 1979. "On the Differentiability of the Value Function in Dynamic Models of Economics," Econometrica, Econometric Society, vol. 47(3), pages 727-32, May.
  11. Svensson, Jakob, 2003. "Why conditional aid does not work and what can be done about it?," Journal of Development Economics, Elsevier, vol. 70(2), pages 381-402, April.
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