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Dynamic Moral Hazard without Commitment

Johannes Hörner and Larry Samuelson (larry.samuelson@yale.edu)
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Larry Samuelson: Cowles Foundation, Yale University, https://economics.yale.edu/people/faculty/larry-samuelson

No 1989, Cowles Foundation Discussion Papers from Cowles Foundation for Research in Economics, Yale University

Abstract: We study a discrete-time model of repeated moral hazard without commitment. In every period, a principal finances a project, choosing the scale of the project and a contingent payment plan for an agent, who has the opportunity to appropriate the returns of a successful project unbeknownst the principal. The absence of commitment is reflected both in the solution concept (perfect Bayesian equilibrium) and in the ability of the principal to freely revise the project's scale from one period to the next. We show that removing commitment from the equilibrium concept is relatively innocuous -- if the players are sufficiently patient, there are equilibria with payoffs low enough to effectively endow the players with the requisite commitment, within the confines of perfect Bayesian equilibrium. In contrast, the frictionless choice of scale has a significant effect on the project's dynamics. Starting from the principal's favorite equilibrium, the optimal contract eventually converges to the repetition of the stage-game Nash equilibrium, operating the project at maximum scale and compensating the agent (only) via immediate payments.

Keywords: Moral hazard; Dynamic moral hazard; Commitment; Principal-agent; Cash flow diversion (search for similar items in EconPapers)
JEL-codes: C72 D82 D86 (search for similar items in EconPapers)
Pages: 48 pages
Date: 2015-02
New Economics Papers: this item is included in nep-cta, nep-gth, nep-hpe and nep-mic
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Published in International Journal of Game Theory (March 2016), 45(1): 89-136

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