DP16888 Self-Enforcing Contracts with Persistence

Author(s): Martin Dumav, William Fuchs, Jangwoo Lee
Publication Date: January 2022
Keyword(s): Dynamic moral hazard, Limited Commitment, Persistence, productivity, Relational Contracts
JEL(s): C73, D24, D82, D86, E24, L14
Programme Areas: Industrial Organization
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=16888

We show theoretically that, in the presence of persistent productivity shocks, the reliance on selfenforcing contracts due to limited legal enforcement may provide a possible rationale why countries with the worse rule of law might exhibit: (i) higher aggregate TFP volatilities, (ii) larger dispersion of firm-level productivity, and (iii) greater wage inequality. We also provide suggestive empirical evidence consistent with the model's aggregate implications. Finally, we relate the model's firm-level implications to existing empirical findings.