CentER Discussion Paper Series No. 2010-85
87 Pages Posted: 27 Aug 2010 Last revised: 2 Sep 2016
Date Written: June 2016
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, Economics: Behavior and Behavioral
JEL Classification: C73, G21, O16, F21, F34
Suggested Citation: Suggested Citation
Brown, Martin and Serra-Garcia, Marta, The Threat of Exclusion and Implicit Contracting (June 2016). European Banking Center Discussion Paper No. 2010-18; University of St.Gallen, School of Finance Research Paper No. 2014/07. Available at SSRN: https://ssrn.com/abstract=1665045 or http://dx.doi.org/10.2139/ssrn.1665045