DP13841 Moral Hazard and the Property Rights Approach to the Theory of the Firm

Author(s): Patrick W. Schmitz
Publication Date: July 2019
Keyword(s): Incomplete Contracts, Investment incentives, moral hazard, Ownership rights, relationship specificity
JEL(s): D23, D86, G34, L23, L24
Programme Areas: Industrial Organization
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=13841

In the Grossman-Hart-Moore property rights theory, there are no frictions ex post (i.e., after non-contractible investments have been sunk). In contrast, in transaction cost economics ex-post frictions play a central role. In this note, we bring the property rights theory closer to transaction cost economics by allowing for ex-post moral hazard. As a consequence, central conclusions of the Grossman-Hart-Moore theory may be overturned. In particular, even though only party A has to make an investment decision, B-ownership can yield higher investment incentives. Moreover, ownership matters even when investments are fully relationship-specific (i.e., when they have no impact on the parties' disagreement payoffs).