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Repeated Moral Hazard, Limited Liability, and Renegotiation

  • Ohlendorf, Susanne
  • Schmitz, Patrick W

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."

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 6725.

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Date of creation: Feb 2008
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Handle: RePEc:cpr:ceprdp:6725
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  27. Cremer, Jacques, 1995. "Arm's Length Relationships," The Quarterly Journal of Economics, MIT Press, vol. 110(2), pages 275-95, May.
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