We would like to thank Patrick Bolton, Bo Chen, Mathias Dewatripont, Oliver Gürtler, Thomas Mariotti, Tymofiy Mylovanov, Andreas Roider, Urs Schweizer, and Jean Tirole for very helpful discussions. Moreover, we are very grateful to two anonymous referees and the editor, Jan Eeckhout, for making valuable comments and suggestions. Financial support by Deutsche Forschungsgemeinschaft, SFB/TR15, is gratefully acknowledged. Please address correspondence to: Patrick W. Schmitz, Department of Economics, University of Cologne, Albertus-Magnus-Platz, 50923 Köln, Germany. E-mail: firstname.lastname@example.org.
REPEATED MORAL HAZARD AND CONTRACTS WITH MEMORY: THE CASE OF RISK-NEUTRALITY*
Article first published online: 21 MAY 2012
© (2012) by the Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association
International Economic Review
Volume 53, Issue 2, pages 433–452, May 2012
How to Cite
Ohlendorf, S. and Schmitz, P. W. (2012), REPEATED MORAL HAZARD AND CONTRACTS WITH MEMORY: THE CASE OF RISK-NEUTRALITY. International Economic Review, 53: 433–452. doi: 10.1111/j.1468-2354.2012.00687.x
Manuscript received August 2008; revised January 2011.
- Issue published online: 21 MAY 2012
- Article first published online: 21 MAY 2012
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 agent can exert unobservable effort, leading to success or failure. Incentives provided in the second period act as carrot and stick for the first period, so that the effort level induced in the second period is higher after a first-period 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.”