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The Threat of Exclusion and Implicit Contracting

Martin Brown () and Marta Serra-Garcia

No 1407, Working Papers on Finance from University of St. Gallen, School of Finance

Abstract: Implicit contracts can mitigate moral hazard in labor, credit and product markets. The enforcement mechanism underlying an implicit contract is the threat of exclusion: the agent fears that he will lose future income if the principal breaks off the relationship. This threat may be very weak in environments where an agent can appropriate income-generating resources provided by the principal. For example, in credit markets with weak creditor protection borrowers may be able to appropriate borrowed funds and generate investment income without requiring further loans. We examine implicit contracting in a lending experiment where the threat of exclusion is exogenously varied. We find that weak exclusion undermines implicit contracting: it leads to a more frequent breakdown of credit relationships as well as to smaller loans.

Keywords: Microeconomic Behavior; Behavior and Behavioral Decision Making; Corporate Finance; Implicit Contracting (search for similar items in EconPapers)
JEL-codes: C73 G21 O16 F21 F34 (search for similar items in EconPapers)
Pages: 86 pages
Date: 2014-04, Revised 2016-06
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Working Paper: The Threat of Exclusion and Implicit Contracting (2016) Downloads
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