DP6725 Repeated Moral Hazard, Limited Liability, and Renegotiation
|Author(s):||Susanne Ohlendorf, Patrick W. Schmitz|
|Publication Date:||February 2008|
|Keyword(s):||Dynamic moral hazard, hidden actions, limited liability|
|Programme Areas:||Industrial Organization|
|Link to this Page:||cepr.org/active/publications/discussion_papers/dp.php?dpno=6725|
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."