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Dynamic Moral Hazard without Commitment

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Abstract

We study a discrete-time model of repeated moral hazard without commitment. In every period, a principal finances a project, choosing the scale of the project and a contingent payment plan for an agent, who has the opportunity to appropriate the returns of a successful project unbeknownst the principal. The absence of commitment is reflected both in the solution concept (perfect Bayesian equilibrium) and in the ability of the principal to freely revise the project's scale from one period to the next. We show that removing commitment from the equilibrium concept is relatively innocuous -- if the players are sufficiently patient, there are equilibria with payoffs low enough to effectively endow the players with the requisite commitment, within the confines of perfect Bayesian equilibrium. In contrast, the frictionless choice of scale has a significant effect on the project's dynamics. Starting from the principal's favorite equilibrium, the optimal contract eventually converges to the repetition of the stage-game Nash equilibrium, operating the project at maximum scale and compensating the agent (only) via immediate payments.

Suggested Citation

  • Johannes Horner & Larry Samuelson, 2015. "Dynamic Moral Hazard without Commitment," Cowles Foundation Discussion Papers 1989, Cowles Foundation for Research in Economics, Yale University.
  • Handle: RePEc:cwl:cwldpp:1989
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    File URL: https://cowles.yale.edu/sites/default/files/files/pub/d19/d1989.pdf
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    References listed on IDEAS

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    More about this item

    Keywords

    Moral hazard; Dynamic moral hazard; Commitment; Principal-agent; Cash flow diversion;
    All these keywords.

    JEL classification:

    • C72 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Noncooperative Games
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law

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