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Title: Repeated Moral Hazard, Limited Liability, and Renegotiation

Author(s): Susanne Ohlendorf and Patrick W. Schmitz

Publication Date: February 2008

Keyword(s): Dynamic moral hazard, hidden actions and limited liability

Programme Area(s): Industrial Organization

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."

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Bibliographic Reference

Ohlendorf, S and Schmitz, P. 2008. 'Repeated Moral Hazard, Limited Liability, and Renegotiation'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=6725