Wealth Constraint and Contractual Arrangements

18 Pages Posted: 20 Jan 2009

See all articles by Chifeng Dai

Chifeng Dai

Southern Illinois University at Carbondale - Department of Economics


We examine how a project owner optimally selects a project operator and motivates him to deliver an unobservable effort when potential operators are wealth constrained. We show that, when potential operators' abilities are common knowledge, an operator's share of realized profit can be increasing, invariant, or decreasing in his ability depending on the nature of production technology. However, when potential operators are privately informed about both their abilities and their effort supply, a bunching contract arises in equilibrium for a general class of production technology. In the case of bunching, all potential operators are selected equally often and awarded an equal share of realized profit. The finding provides an explanation for the relative uniformity of contract terms in many practical settings.

Suggested Citation

Dai, Chifeng, Wealth Constraint and Contractual Arrangements. Canadian Journal of Economics/Revue canadienne d'économique, Vol. 42, Issue 1, pp. 226-243, February/février 2009. Available at SSRN: https://ssrn.com/abstract=1330644 or http://dx.doi.org/10.1111/j.1540-5982.2008.01506.x

Chifeng Dai (Contact Author)

Southern Illinois University at Carbondale - Department of Economics ( email )

Mail Code 4515
Carbondale, IL 62901-4515
United States

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