Repeated Moral Hazard, Limited Liability, and Renegotiation
28 Pages Posted: 11 Jun 2008
Date Written: February 2008
Abstract
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."
Keywords: Dynamic moral hazard, hidden actions, limited liability
JEL Classification: C73, D86
Suggested Citation: Suggested Citation
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