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Contracting with Endogenously Incomplete Commitment: Escape Clauses

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We study mechanism design under endogenously incomplete commitment as it arises in contracting with escape clauses. An escape clause permits the agent to end a contractual relationship under specified circumstances, after which the principal can offer an ex-post contract. Escape clauses are valuable when the maximal number of initial contracts is smaller than the number of agent types. We identify a sufficient condition for incentive optimality of ex-post contracting. Escape clauses are always incentive optimal under severely constrained contracting. On the margin, the optimal escape clause balances the benefit of a better-adapted contract against an increase in dynamic inefficiency.

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  • Tangerås, Thomas & Gick, Wolfgang, 2021. "Contracting with Endogenously Incomplete Commitment: Escape Clauses," Working Paper Series 1390, Research Institute of Industrial Economics.
    • Handle: RePEc:hhs:iuiwop:1390
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    More about this item

    Keywords

    Constrained contracting; Escape clauses; Endogenously incomplete commitment; Ratchet effect; Revelation principle;
    All these keywords.

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law

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