Self-Enforcing Contracts in Continuous Time

We study self-enforcing contracts in a continuous-time Poisson framework, where a risk-neutral agent with limited liability exerts effort to increase the likelihood of success in a good-news project. Dynamic enforcement is irrelevant for contracts aimed at avoiding bad outcomes but important when effort generates positive outcomes. We propose a two-step approach: first, we characterize the optimal commitment contract under an exogenous bound on the agent’s continuation utility; second, we determine the maximal bound the principal can credibly offer to implement the optimal self-enforcing contract. The resulting contract backloads payments and features a termination threshold, a partial-bonus threshold, and a full-bonus threshold. Comparative statics show that self-enforcing contracts more closely approximate the commitment benchmark when projects are either gradualist—featuring more frequent, smaller successes—or smaller in scale, with lower effort costs and reduced success payoffs. These patterns imply that, in environments lacking strong institutions, ambitious or high-scale projects are unlikely to be undertaken, effectively limiting the scope of self-enforcement to gradualist or low-scale undertakings.