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Repeated Moral Hazard, Limited Liability, and Renegotiation

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  • Ohlendorf, Susanne
  • Schmitz, Patrick W

Abstract

We consider a repeated moral hazard problem, where both the principal and the wealth-constrained agent are risk-neutral. In each of two periods, the principal can make an investment and the agent can exert unobservable effort, leading to success or failure. Incentives in the second period act as carrot and stick for the first period, so that effort is higher after a success than after a failure. If renegotiation cannot be prevented, the principal may prefer a project with lower returns; i.e., a project may be "too good" to be financed or, similarly, an agent can be "overqualified."

Suggested Citation

  • Ohlendorf, Susanne & Schmitz, Patrick W, 2008. "Repeated Moral Hazard, Limited Liability, and Renegotiation," CEPR Discussion Papers 6725, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:6725
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Spear, Stephen E. & Wang, Cheng, 2005. "When to fire a CEO: optimal termination in dynamic contracts," Journal of Economic Theory, Elsevier, vol. 120(2), pages 239-256, February.
    2. Nieken, Petra & Schmitz, Patrick W., 2012. "Repeated moral hazard and contracts with memory: A laboratory experiment," Games and Economic Behavior, Elsevier, vol. 75(2), pages 1000-1008.
    3. Cheng Wang, 2000. "Renegotiation-Proof Dynamic Contracts with Private Information," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 3(3), pages 396-422, July.
    4. Kräkel, Matthias & Schöttner, Anja, 2010. "Minimum wages and excessive effort supply," Economics Letters, Elsevier, vol. 108(3), pages 341-344, September.
    5. David Martimort & Stéphane Straub, 2016. "How To Design Infrastructure Contracts In A Warming World: A Critical Appraisal Of Public–Private Partnerships," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 57, pages 61-88, February.
    6. Kräkel, Matthias & Schöttner, Anja, 2010. "Minimum wages and excessive effort supply," Economics Letters, Elsevier, vol. 108(3), pages 341-344, September.
    7. David Martimort & Stéphane Straub, 2011. "How to Design Public-Private Partnerships in a Warming World? - When Infrastructure Becomes a Really “Hot” Topic," Working Papers 2011/25, Maastricht School of Management.
    8. Stefanie Aniela Lehmann, 2008. "When Randomization in Collective Tournaments is Profitable for the Principal," Bonn Econ Discussion Papers bgse19_2008, University of Bonn, Germany, revised Mar 2009.

    More about this item

    Keywords

    Dynamic moral hazard; hidden actions; limited liability;

    JEL classification:

    • C73 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Stochastic and Dynamic Games; Evolutionary Games
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law

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