Contracting with Endogenously Incomplete Commitment: Escape Clauses

Thomas Tangerås () and Wolfgang Gick

No 1390, Working Paper Series from Research Institute of Industrial Economics

Abstract: We study mechanism design under endogenously incomplete commitment as it arises in contracting with escape clauses. An escape clause permits the agent to end a contractual relationship under specified circumstances, after which the principal can offer an ex-post contract. Escape clauses are valuable when the maximal number of initial contracts is smaller than the number of agent types. We identify a sufficient condition for incentive optimality of ex-post contracting. Escape clauses are always incentive optimal under severely constrained contracting. On the margin, the optimal escape clause balances the benefit of a better-adapted contract against an increase in dynamic inefficiency.

Keywords: Constrained contracting; Escape clauses; Endogenously incomplete commitment; Ratchet effect; Revelation principle (search for similar items in EconPapers)
JEL-codes: D82 D84 D86 (search for similar items in EconPapers)
Pages: 55 pages
Date: 2021-05-28
New Economics Papers: this item is included in nep-cta, nep-mic and nep-reg
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